EURO GOVT-Bunds steady after ECB rate shock

* Bunds consolidate after post-ECB losses

* 2-yr yields highest since Jan 2009, seen heading for 2pct

* Portugal to sell 2-yr bonds next week

By Kirsten Donovan

LONDON, March 4 (Reuters) – German government bonds
consolidated on Friday after the previous day’s sharp rise in
yields on the prospect of tighter monetary policy and with
equities up on optimism U.S. jobs data will beat forecasts.

Bund yields pushed sharply higher and the curve flattened
after the European Central Bank stunned markets by indicating it
could raise interest rates as soon as next month.

“The market did what it should have yesterday but there
wasn’t much client flow so we may see that coming in today and
the curve flattening didn’t feel like it went far enough,” a
trader said.

Traders said there was however an unwillingness to put on
new longer-term positions ahead of the U.S. payrolls report
which can cause sharp short-term market moves.

March Bund futures (FGBLc1: Quote, Profile, Research) were 2 ticks lower at 122.84.
Two-year bond yields (DE2YT=TWEB: Quote, Profile, Research) were down half a basis point
at 1.767 percent, their highest levels since January 2009, with
10-year yields (DE10YT=TWEB: Quote, Profile, Research) down 1.5 bps at 3.31 percent.

Morgan Stanley strategists note that two-year yields tend to
trade at about 80 bps over the ECB’s refinancing rate —
currently 1 percent — during rate hike cycles and therefore see
two-year yields heading above 2 percent.

The 2/10 year yield curve was at 155 bps, its flattest level
since late 2010. When the ECB last started a rate hiking cycle
at the end of 2005, the 2/10 yield curve was at about 60 basis
points, ultimately flattening to near zero through 2007,
according to Reuters data.

ING rate strategist Alessandro Giansanti noted the risk
premium at the long-end of the curve related to increased
government bond issuance prevented the bullish curve flattening
normally seen at the end of an easing cycle but he sees room for
around 60 bps of further flattening from current levels.


Peripheral spreads widened only modestly despite analysts
saying higher interest rates would be a negative for the
struggling economies.

“It could be that the market believes when push comes to
shove, the policymakers will come up with the goods or there is
an unwillingness to short the market given the ongoing
possibilities of European Central Bank (bond buying),” said
Richard McGuire, rate strategist at Rabobank.

European Union leaders from centre-right political parties
meet in Helsinki and will discuss the euro zone debt crisis,
trying to forge a common position before two critical summits
later this month [ID:nLDE72225Z].

“The problem is that you have a two-speed Europe and a rate
hike is going to hurt the periphery so it puts pressure on the
EU leaders to come up with something,” the trader said.

The U.S. February employment report is released at 1330 GMT
and economists in a Reuters survey forecast 185,000 jobs were
created although a better than expected private sector jobs
report earlier this week has heightened expectations of a
stronger number.

“The surprise potential in today’s release is tilted to the
upside with chances in favour of bearish steepening… on the
U.S. curve,” Commerzbank strategists said in a note.

They added any potential bull-flattening in case of a
downside surprise could be used to add to 2-10 Treasury curve
steepeners versus Bund curve flatteners.

Portugal said it will offer up to 1 billion euros of
two-year bonds next week and analysts said the small size and
short maturity should help the sale.
The county’s last sale, a syndicated 5-year deal has traded
underwater since it’s launch. The bond was quoted at 97.38,
according to Reuters data, compared with an issue price of 99.76
(PTOTEPOE016=: Quote, Profile, Research).