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UPDATE 2-Euro zone bond yields drift lower after dovish BoE

·3 min read

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Adds details, updates prices)

By Dhara Ranasinghe

LONDON, June 24 (Reuters) - Government bond yields in the euro area drifted lower on Thursday after the Bank of England left policy steady, as the bloc's debt investors continued to seek direction in the aftermath of last week's Federal Reserve meeting.

The Bank of England kept the size of its stimulus programme unchanged, as widely expected, despite inflation zipping past its target in May, just as other major central banks start to position for the end of emergency stimulus. That sent British government bond yields down.

Euro area bond yields, which were up earlier in the day, drifted lower after the decision, with Germany's 10-year yield, the benchmark for the region, down 0.5 basis points to -0.185% by 1454 GMT.

Earlier, yields were marginally higher as Germany's Ifo institute said its business climate index hit its highest level since November 2018 on companies' surging optimism about the second half of the year in Europe's largest economy.

It followed IHS Markit's Flash Composite Purchasing Managers' Index on Wednesday, which is seen as a good guide to economic health, jumped to 59.2 in June, its highest reading since June 2006.

"Bond markets appear to have found a new balance after the Fed-induced volatility eruption last week," said Christoph Rieger, head of rates and credit research at Commerzbank.

"While Bunds stabilised, the long-end curve re-steepened further and (inflation) break-evens re-widened, suggesting that fundamentals are slowly taking over from positioning again."

The five-year, five-year breakeven inflation forward, a market gauge of long-term inflation expectations in the euro area, rose to almost 1.58%. It has risen sharply from a three-month low hit below 1.50% at the start of the week.

Analysts expect signs of a strengthening economy to keep upward pressure on borrowing costs. Germany's 10-year Bund yield has risen around 8 bps from lows hit a day after the European Central Bank's reaffirmed its dovish policy stance at its June 10 meeting.

A hawkish shift by the U.S. Federal Reserve last week added to upward pressure.

BofA revised its 10-year German yield target to -0.05% from -0.25%, expecting it to trade around that level throughout the first half of 2022, citing potential for inflation to accelerate into year-end and a pick-up in net issuance in 2022.

Elsewhere, Italy raised 6 billion euros from a floating-rate seven-year bond.

"The maturity of the new floater will be longer than usual. In our view, this reflects Italy’s objective of lengthening its debt maturity," analysts at UniCredit said in a note.

Italy's 10-year bond yields dropped after the sale, last down 3 basis points at 0.86%. (Reporting by Dhara Ranasinghe, additional reporting by Yoruk Bahceli; Editing by Lincoln Feast and Emelia Sithole-Matarise)