EURO GOVT-German curve steepens on strong ECB loan demand

* Schatz rallies after strong bank demand for ECB loans

* German 2/10-year bond yield curve steepens to 200 bps

* Peripheral yields drift up as Fitch mulls Greece downgrade

By William James

LONDON, Dec 22 (BestGrowthStock) – Two-year German debt yields fell
on Wednesday, steepening the yield curve as strong demand from
banks for ECB funding looked set to keep pushing down
short-dated rates into next year.

The prospect of a large liquidity surplus in the banking
system spilled into the short end of the euro zone’s benchmark
yield curve after demand for three-month ECB loans exceeded
expectations. The yield spread between two- and 10-year German
bonds widened to 200 basis points, 5.5 bps wider on the day.

However, analysts said the move may be short-lived if banks’
borrowing at a 14-day tender on Thursday was low, with more than
200 billion euros of European Central Bank loans due to be
repaid. [ID:nLDE6BL0O8]

“We will continue to have a decent excess of liquidity so
the front end should continue to be very solid, but as far as
today’s rally is concerned, I think it could be a little
overdone,” said Patrick Jacq, strategist at BNP Paribas.

Bund futures (FGBLc1: ) benefited from a stronger tone in U.S.
Treasury markets to settle 30 ticks higher at 125.47. U.S. debt
pared early losses after revised third-quarter U.S. GDP came in
below forecasts. [ID:nN22291841]

Two-year German yields (DE2YT=TWEB: ) were 8.4 bps lower at
0.956 percent, with 10-year yields (DE10YT=TWEB: ) down 3 bps at
2.952 percent.

Tension in higher-yielding euro zone sovereign debt markets
remained elevated after Fitch Ratings said late on Tuesday there
was a growing probability it would cut Greece’s rating to “junk”
status. That followed Moody’s warning earlier on Tuesday that it
could downgrade Portugal. [ID:nLDE6BK0HE]

“There’s been no clarity on what European Union leaders will
do to deal with the debt crisis. That uncertainty, coupled with
the threat of downgrades to various peripheral countries has led
to more spread widening and a weaker euro,” said Investec
economist Philip Shaw.

The Greek/German 10-year yield spread was around 7 bps wider
on the day at 928 bps, but with Greek bonds already yielding
over 12 percent, the scope for further widening was limited.

Portugal’s government bonds (PT10YT=TWEB: ) also
underperformed but regained some ground after a Portuguese
newspaper said China was ready to buy 4 to 5 billion euros of
Portuguese debt to help the country ward off market pressure.
[ID:nLDE6BL0MW]

“The only new thing is the figure but the report is
unsourced so although it’s providing a bit of support, clients
certainly aren’t putting much weight on it,” said one trader.

PERIPHERAL TENSION HIGH

The pre-Christmas market lull has taken some of the heat off
peripheral euro zone debt, but analysts expect pressure to
intensify again in the New Year when governments must resume
issuing bonds to repay maturing debt.

“The danger is investors aren’t putting their chips on the
table at this time of year and come January 4 that there is
renewed selling pressure on peripheral bonds and the currency,”
Investec’s Shaw said.
Already this month, Moody’s has put Spain and Greece on
review for possible downgrades and cut Ireland’s rating by a
savage five notches, while S&P said it may cut Belgium’s debt
rating next year.

Yield premiums over Bunds have been trending higher with the
10-year Spanish spread near 260 basis points, up from around 225
bps at the start of this month, and the Portuguese spread up
around 60 bps.
(Additional reporting by Kirsten Donovan; Editing by Susan
Fenton)

EURO GOVT-German curve steepens on strong ECB loan demand