LONDON: Most euro zone bond yields rose on Tuesday as fears of a global trade war ebbed, taking the shine off safe-haven debt as attention turned to this week's ECB meeting for clues as to how and when the bank will withdraw its hefty stimulus programme.
Italy's government bonds recovered from a selloff on Monday, sparked by a surge in support for anti-establishment parties in Sunday's inconclusive national election.
The premium investors demand to hold 10-year Italian debt over its benchmark German equivalent fell back to levels last seen before Sunday's election at around 139 basis points.
As investors awaited further news on the make-up of the next government in Italy, the euro zone's third biggest economy, Thursday's European Central Bank meeting shifted into focus.
Policymakers are likely to discuss dropping their easing bias - a stipulation that asset buys could be increased if necessary - but a broader revision of the bank's policy guidance is likely to happen later, possibly during the summer, sources told Reuters last week.
A strong economy means the ECB is widely expected to end its 2.55 trillion euro stimulus scheme by year-end, confident that inflation will at some point rise slowly.
"The ECB is going to be presenting growth forecasts that are likely to be stronger, but will be at pains to stress that the move away from monetary easing will be delicately done and slowly," said Peter Chatwell, head of euro rates strategy at Mizuho.
Low inflation remains a key reason for the cautious stance. Data last week showed euro zone inflation slowed to a 14-month low at 1.2 percent, and a key market gauge of long-term expectations on Monday dipped below 1.70 percent to its lowest level this year.
Most better-rated euro zone bond yields across bloc were up 1-2 basis points, with Germany's 10-year Bund yield up 2.5 bps at 0.66 percent - above five-week lows hit on Monday at around 0.60 percent.
Investor worries about an imminent trade war eased as US President Donald Trump faced pressure from political allies to pull back from proposed steel and aluminium tariffs. That boosted stocks and dented demand for fixed income.
WHAT ELECTION?
Italy's 10-year bond yield fell 5.5 bps to 2.03 percent , with peripheral peers Spain and Portugal also down 5-6 basis points.
Analysts have been surprised by the relatively subdued bond market reaction to Sunday's Italian vote, predicting uncertainty about the make-up of the next government would likely weigh on Italian bonds in the coming weeks.
"All else equal, the risk of a populist government has increased compared with before the weekend so I would have expected much more weakness in peripheral spreads," said ABN AMRO senior fixed income strategist Kim Liu.
"I would actually expect that weakness in coming days and weeks as developments unfold."
Elsewhere, Germany sold around 400 million euros of 2026 inflation-linked bonds and Austria auctioned 1 billion euros of debt.
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