* Low-rated bonds of Portugal and Italy underperform
* Tapering of ECB's bond-buying begins Monday
* Euro zone inflation falls below expectations
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
(Updates prices to close)
By John Geddie
LONDON, March 31 Euro zone debt markets on
Friday offered a glimpse of what life could be like for the
bloc's weaker economies when the central bank starts to withdraw
its monetary stimulus scheme next week.
The yield, an indication of borrowing costs, on bonds of
southern euro zone states including Portugal, Italy and Spain
pushed higher in the final day of trading before the European
Central Bank drops its monthly bond purchases from 80 billion to
60 billion euros.
These weaker, so-called peripheral states are seen as most
dependent on the trillions of euros the ECB has spent over the
last few years to shore up growth and inflation.
And as a tentative recovery gathers steam, some
policymakers, including Dutch central bank head Klaas Knot, are
calling for speedier "tapering" of the scheme set to run until
at least December.
"The unwinding generally is a risk-off event and for a lot
of peripheral countries it doesn't take a lot in terms of higher
financing costs for their debt stock to look problematic,"
Rabobank strategist Lyn Graham-Taylor said.
Rabobank estimates that the gap between Italian and
benchmark German bond yields, already around the widest in three
years, could stretch by another 85 basis points as the ECB
The first step of that is the scaling back of its government
bond-buying scheme, which takes effect on Monday, and investors
have become increasingly nervous about how quickly policymakers
might tighten policy thereafter.
Some officials have argued that the ECB could raise rates
before it ends asset buys, a move that would be counter to its
current guidance, but others have dismissed such a discussion.
The ECB's tapering comes as the United States is tightening
monetary conditions. New York Fed President William Dudley
called on Thursday for more rate hikes and an eventual trimming
of its bond portfolio.
While benchmark German bonds yields were little changed on
Friday, low-rated bond yields rose. Portuguese, Italian and
Spanish 10-year yields climbed 2-4 basis points to 4.00 percent
, 2.33 percent and 1.66 percent
respectively, drifting from multi-week lows on
"The next two months will be more threatening for longs as
U.S. data improves, political risk in Europe ebbs, and investors
refocus on progressive central bank exits from easy money,"
Societe Generale strategist Ciaran O'Hagan said.
Reuters revealed this week that ECB officials are wary of
making any new change to their policy message at their April
meeting after small tweaks to their forward guidance this month
That view was reinforced by weaker-than-expected euro zone
inflation data on Friday and comments from Executive Board
member Benoit Coeure that the ECB's policy guidance remains
valid for now but could change if inflation fundamentals
In the last two weeks alone, Germany's 10-year yield - the
bloc's benchmark - has swung from 14-month highs of 0.51 percent
to one-month lows of 0.32 percent on Thursday.
Markets further trimmed expectations for ECB rate rises on
Friday, while a long-term gauge of euro zone inflation
expectations fell to its lowest since late November
Weak consumer spending data also rattled French bonds on
Friday, adding to investor nerves about the coming presidential
election, in which one of the leading candidates is far-right
eurosceptic Marine Le Pen.
French 10-year bond yields rose 3 basis points to 0.97
percent, coming off Thursday's near one-month low.
The euro edged up against the U.S. dollar but was within
sight of a two-week low.
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
(Editing by Andrew Roche)