ECB taper fears leave euro zone bonds battered and bruised

The dismantled Euro sign sculpture stand in front of the headquarters of the former European Central Bank (ECB) in Frankfurt

By Dhara Ranasinghe

LONDON (Reuters) – Euro zone government bond yields edged higher on Friday, adding to heavy losses earlier in the week as investors reassess the outlook for fixed income on perceptions that an era of ultra-cheap money is gradually ending.

Euro zone growth is picking up but underlying inflation is still weak, so the European Central Bank should adjust its policy carefully and flexibly to avoid abrupt market moves, ECB board member Benoit Coeure told two European newspapers.

The Bank of Japan meanwhile said it would purchase an unlimited amount of bonds as it seeks to put a lid on domestic interest rates pushed higher by the broad sell-off in developed market bonds.

Euro zone bond yields, which jumped as much as 12 basis points on Thursday as minutes from the ECB’s latest meeting showed policymakers are open to a further step towards reducing monetary stimulus, rose 1-2 basis points on Friday.

They were thrust higher after data showed the U.S. economy added more jobs than expected in June and employers increased hours for workers, signs of labor market strength.

Germany’s benchmark 10-year Bund yield edged up to 0.58 percent <DE10YT=TWEB>, a fresh 18-month high.

Low-rated Italian, Spanish and Portuguese government bond yields, seen as particularly vulnerable to unwinding of extraordinary stimulus, were particularly hard hit, rising 5-8 bps. <IT10YT=TWEB> <PT10YT=TWEB> <ES10YT=TWEB>

“The market is unlikely to keep selling off without fresh information…But sentiment remains bearish,” said Orlando Green, European fixed income strategist at Credit Agricole.

In just over a week, Bund yields have doubled, with German bonds bearing the brunt of selling in euro zone debt markets.

“If the market is going to conclude that monetary policy makers are making an effort to tighten, we should have spreads widening, so that could be the next shoe to drop as the sell-off starts to impact credit and equities,” said Peter Chatwell, head of euro rates strategy at Mizuho.

Jitters about tighter monetary policies from major central banks have rippled throughout global markets, hurting stocks and supporting the euro.

U.S. Treasury yields <US10YT=RR> rose on Thursday on the back of the employment data and concern that rising oil prices could spur inflationary pressures. Meanwhile, 10-year Japanese government bond yields <JP10YTN=JBTC> hit five-month highs on Friday before the BOJ said it would buy JGBs.

(Reporting by Dhara Ranasinghe; Editing by Mark Heinrich)