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Euro bond yield plunge on contagion fear

Friday, January 31 17:32:05

Euro zone bond yields and money market rates slid today after an unexpected drop in inflation intensified speculation the European Central Bank may ease its policy in coming months.

Spanish 10-year yields fell close to the eight-year lows hit earlier this month, while equivalent German, Italian, Belgian, Austrian, Finnish, and Dutch yields hit their lowest in six to seven months.

Inflation in the euro zone fell to 0.7 percent in January from 0.8 percent the previous month and compared with a forecast of 0.9 percent in a Reuters poll. The figure is well below the ECB's target of nearly 2 percent.

"This obviously raises the stakes for the ECB," said Ciaran O'Hagan, rate strategist at Societe Generale in Paris.

"Last time around (ECB President) Mr Draghi said the low inflation reading was an aberration to be corrected but it's getting harder and harder to explain."

Money market rates suggest investors expect the ECB to hold fire at its meeting next week: forward overnight bank-to-bank euro lending rates dated for the February meeting, at 0.18 percent, are higher than the spot Eonia rate of 0.155 percent.

The downward trajectory of money market rates maturing beyond February, however, indicates expectations the ECB may ease its policy later this year. The biggest declines - up to 5 bps on the day - were seen in Eonia rates from May to November - all trading at or around their lowest since mid-2013.

"The market is clearly expecting something from the ECB either a rate cut or something on the liquidity side," said Jean-Francois Robin, head of rates strategy at Natixis. "That might be the big danger here if the ECB does nothing maybe market reaction might be a bit violent in this regard. (Reuters)