Oil-price jump gives investors another reason to bash bonds

By Dhara Ranasinghe

LONDON (Reuters) - Government bond yields rose across the euro zone on Thursday as a jump in oil prices reinforced expectations that a pick up in inflation could encourage the European Central Bank to step back from its ultra-loose monetary policy in coming months.

Oil prices extended their 3 percent-plus overnight gains, their biggest one-day jump since Dec. 1, following a steep drop in U.S. inventories and support from Iraq and Algeria for an extension to supply cuts from the Organization of the Petroleum Exporting Countries.

That rally has helped boost the market's long-term euro zone inflation expectations, with the five-year breakeven forward bouncing off a low hit on Monday just below 1.60 percent.

 

Analysts say the path for bond yields has turned higher as fading political risks and stronger data fuel talk that the ECB could signal a policy shift when it meets in June.

"Oil is one factor in the bond market move today but the strongest factor driving the trend is a view that in June the ECB may change its tone and forward guidance," said Patrick Jacq, Europe rate strategist at BNP Paribas.

Ten-year bond yields in the euro area rose 2-3 basis points on the day, with Germany's benchmark Bund yield up 2.5 bps at 0.44 percent.

It has risen roughly 28 bps in the past three weeks, a period that coincides with the conclusion of the French presidential election, a pick-up in global risk appetite and a shift in focus to the timing of U.S. rate hikes and the ECB's next move.

On Wednesday, ECB President Mario Draghi said it is too early for the ECB to declare victory in its quest to boost inflation despite signs the bloc's economic recovery is strengthening.

But he also hinted at potential changes to the bank's ultra-loose policy message, saying downside risks have further diminished.

"His comments were interpreted as a possible shift in June in the ECB's statement," said DZ Bank strategist Daniel Lenz. "In general we are now in an upward trend for yields so when we have comments like these, they fuel the bond market moves."

Money markets also reflect rising expectations for a change in ECB policy in the months ahead and price in 70 percent chance of rate hike early next year.

Focus was expected to turn later in the session to Italy, which auctions up 7.25 billion euros of government debt, and Britain where the Bank of England meets.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

(Reporting by Dhara Ranasinghe; Editing by Janet Lawrence)