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UPDATE 1-Peripheral bonds rally after strong sales, ECB easing hints
05/13/2014 Email this story  |  Printable Version

* Demand for Spain's first linker tops 20 bln euros

* ECB easing expectations push euro zone yields lower

* Weak US retail sales send Bund yields to 50-week low

* PIMCO sees bull market ending, but bears quiet (Adds comments, updates prices)

By Marius Zaharia and John Geddie

LONDON, May 13 (Reuters) - Low-rated euro zone bond yields fell back towards record lows on Tuesday, as a raft of debt sales met strong demand from investors expecting the European Central Bank to ease monetary policy further.

Spain's first-ever inflation-linked bond drew bids of more than 20 billion euros. Italy reached the top of its target range, selling 7.25 billion euros of debt, while Germany and the Netherlands also easily dispatched bonds. After those strong auctions, Italy mandated a bank syndicate for a 20-year sale.

The ECB's outlook drove yields lower and supported demand. A Dow Jones report quoted unnamed sources as saying the Bundesbank would back an interest rate cut next month, after ECB President Mario Draghi said last week the governing council felt "comfortable" with easing policy in June.

Sources later told Reuters the Bundesbank was ready to support ECB policy action if it is needed.

Bond fund giant PIMCO said loose central bank policy should herald an era of low returns but less downside risk over the next three to five years.

In the report released on the firm's website, Pimco said that neutral policy interest rates close to zero percent suggest "an end to bull markets as we've known them, but no perceptible growling from the bears".

Euro zone bond yields were last 1-6 basis points down, having started the day flat or a touch higher as investors made room in their books for the new paper.

Spanish, Irish and Italian yields traded just above the record lows they reached last week, while Greece was the only outlier, where yields rose 16bp on the day to 6.42 percent.

German 10-year Bund yields, the benchmark for euro zone borrowing costs, fell 4 bps to a 50-week low of 1.42 percent. Traders said Bund yields also fell in step with US Treasuries, after weak US retail sales data raised questions over the strength of the US recovery and the pace of rates rises in the world's largest economy.

FREE OPTION

While low official rates have a direct correlation to lower nominal bond yields, investors said demand for Spain's inflation-linked debt was based on expectations that looser ECB policy would eventually succeed in lifting ultra-low consumer price growth.

"Inflation linkers ... look like a free option on potential aggressive action next month," said Marion Le Morhedec, senior portfolio manager at AXA Investment Managers.

Analysts said Spain's sale of 5 billion euros of inflation-linked bonds allowed it to tap a hungry domestic base that until now could hedge against inflation only by buying German, Italian or French debt.

The possibility that some investors would switch from Italian linkers into Spanish ones in the near term to diversify their portfolio raised the prospect of short-term gains in the Spanish market, luring hedge funds into the sale, traders said.

"Also, everybody expects the ECB to act and anchor inflation expectations," said Natixis fixed income strategist Cyril Regnat, who said Spain's debt sale was "quite impressive".

With the linker sale, Spain has now shifted around 51 percent of its end-of-year target for medium- and long-term debt. Italy has also completed almost half its issuance programme for this year with Tuesday's sale.

"Spain and Italy are well advanced with their funding for this year so yields have more room to compress," said Annalisa Piazza, a marker economist at Newedge. (Reporting by Marius Zaharia and John Geddie; Editing by Larry King and Susan Thomas)


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