ECB split on stimulus dampens demand for long-dated euro zone bonds

[LONDON] A growing split among euro zone policymakers has made investors question how long the current level of stimulus can last, leading to a reduction in demand for long-dated government bonds in the bloc.

The yield spread between Germany's 10 and 30-year bonds hit its widest in 18 months on Friday. Long-dated bonds tend to be more sensitive to changes in the political and policy outlooks, and more likely to sell off if there is a move towards tightening policy.

While European Central Bank chief Mario Draghi insisted this week that extraordinary stimulus measures are still necessary, other policymakers have opposed this view ahead of next week's ECB meeting.

Bundesbank President Jens Weidmann, a long-time critic of the ECB's exceptional stimulus, said on Wednesday that with the euro zone recovery gaining strength, inflation would continue to rise even if the ECB reduced stimulus.

Analysts say this split among policymakers is behind the reduced demand for long-dated bonds, but also explains the potential for issuance in that part of the curve as borrowers seek to lock in low costs.

"While there are many uncertainties about what the ECB will do, there is a growing feeling that we are now past the peak of quantitative easing - and in that situation, investors are most concerned about potential losses on long-dated bonds," said DZ Bank strategist Daniel Lenz.

A Reuters poll of economists showed expectations are for the ECB to raise its assessment of risks to balanced or begin discussing a shift from its bias to ease policy at the June 8 meeting.

Commerzbank analysts say the euro zone government bond curves - the gap between yields on short and long-dated bonds - can steepen further with speculation about more supply and less quantitative easing on the rise.

The spread between Germany's 10 and 30-year bond yields hit 86 basis points early on Friday, its highest since January 2016, before narrowing a touch.

The spread between Italy's 10 and 30-year bond yields was at 111 basis points, a 2 1/2 month high.

"The ultra-long widening stands out compared to the much more contained moves across the curve, suggesting that speculation regarding a new 30-year BTP benchmark are at play with the (Italian debt agency) to front-run potential election fears," the analysts said in a note.

Most 10-year euro zone bond yields edged lower 1-2 bps on Friday. Italy's 10-year yield was an outperformer with a 2 basis point drop to 2.22 per cent, but only after having risen 15 bps since the start of the week.

US employment figures due out later on Friday could have further implications for monetary policy, with analysts suggesting a strong figure could mean that the US Federal Reserve will hike rates in June.

A Reuters poll shows economists expect 185,000 non-farm jobs were added in May.

REUTERS