LONDON: Euro zone government bond yields were mostly steady on Thursday, with investors holding fire ahead of a key European Central Bank meeting at which it is expected to dial back stimulus but pledge to keep borrowing costs low.
The prospect of US interest rates rising earlier than expected failed to budge bond markets with looming Bank of England, Swiss National Bank and Norwegian central bank meetings later on adding to caution.
The Federal Reserve on Wednesday said it would end its pandemic-era bond purchases in March and pave the way for three quarter-percentage-point rate hikes by end-2022 as the economy nears full employment and inflation surges.
In early trade, Germany's Bund yield was steady at -0.37% , hardly moved on the day and sticking to the narrow range it has held all week.
Italian 10-year bond yields were 2 basis points lower at 0.90%, perhaps reflecting some optimism among that the ECB will maintain a hefty presence in bond markets even as it looks to step back from aggressive stimulus.
The ECB is expected to announce that bond buys under its 1.85 trillion euro ($2.09 trillion) Pandemic Emergency Purchase Programme (PEPP) will be reduced next quarter then wound down at the end of March. A long-running Asset Purchase Programme (APP), however, will be ramped up, offsetting some of this lost stimulus.
Uncertainty created by the Omicron coronavirus variant means the ECB could delay some decisions on what shape its support after April will take.
ECB hawks warn against adding to APP when inflation could remain too high longer-term. Doves want to stick with ultra-easy policy because long-term price pressures remain weak.
"Markets are worried that we could get a hawkish meeting. (ECB chief Christine) Lagarde is trying to bring a consensus between a clearly divided council," said David Riley, chief investment strategist at BlueBay Asset Management.
A key focus is what shape ECB support takes once PEPP ends.
The most likely option is that policymakers approve a bond purchase quota or "envelope" for 2022 and emphasize that not all of this must be spent.
It could regularly review the exact volumes and set purchase targets only for short periods. The biggest risk is that investors start selling bonds from the bloc's indebted periphery.
"Communication will be key and how the ECB stresses the flexibility it wants to maintain to reduce risks to the economy at a time where there are additional risks on the virus side," said Annalisa Piazza, fixed-income research analyst at MFS Investment Management.
She said two sources of potential volatility for the periphery could come from how much flexibility the ECB flags in terms of reinvestments from maturing bonds in the PEPP, and the size of purchases under APP.
An envelope size of 120 billion euros for asset purchases after March would be viewed as hawkish, Piazza said.
The 10-year Italian/German bond yields spread has widened over the past two months to around 125 bps, up from around 90 bps early this year.
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