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UPDATE 2-Falling inflation expectations keep euro zone yields near multi-month lows
June 22, 2017 / 10:51 AM / 3 months ago

UPDATE 2-Falling inflation expectations keep euro zone yields near multi-month lows

* Inflation gauge nears 1.50 pct for first time this year

* Investors worry ECB will struggle to meet inflation target

* Italian yields hit fresh lows as political concerns ease

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Abhinav Ramnarayan

LONDON, June 22 (Reuters) - Euro zone government bond yields struck or were near multi-month lows on Thursday as an oil slump added to concerns about inflation and whether the European Central Bank would be able to tighten policy any time soon.

Triggered by Wednesday’s sharp fall in oil prices, a key gauge of long-term euro zone inflation expectations came close to 1.50 percent for the first time this year, well off its February peak of 1.80 percent.

This raises further doubts about the ECB’s ability to meet its inflation target of just below 2 percent, analysts said.

“It’s not good news for the ECB and it maybe reinforces expectations that (ECB President Mario) Draghi can’t get inflation back on target, a problem in the U.S. as well at the moment,” said ING strategist Martin van Vliet.

“If inflation is not reviving, the ECB needs to keep a loose policy stance, which helps the periphery in particular.”

Lower-rated southern European government bonds are seen as the biggest beneficiaries of the ECB’s bond buying scheme.

Italian debt outperformed the rest of the market, its 10-year debt dropping as much as 5 basis points to a fresh five-month low of 1.86 percent. As European trading came to a close, it was at 1.89 percent.

The country’s 30-year borrowing costs dropped below 3 percent for the first time since early January.

The yield on Spain’s 10-year government bonds fell as much as 4 bps to a five-month low at 1.33 percent, before edging back up to 1.36 percent.

Italian government bonds have benefited after the possibility of a snap election faded and anti-establishment party 5-Star Movement, while riding high in national opinion polls, suffered a beating in local votes.

In addition, 5-Star Movement has also relegated its pledge to hold a referendum on the euro - a key concern for the market - to “plan B”.

But many higher-rated euro zone government bond yields are not far off recent lows either. Germany’s 10-year yield , the benchmark for the region, shed a couple of basis points on Thursday to trade at 0.24 percent, not far from a one-month low of 0.225 percent hit last week.

French and Belgian 10-year borrowing costs are also close to their lowest levels of 2017.

“Central bankers would have thought that after a year, weakness in oil would have been washed away but you can see in the market that market-based inflation expectations move closely with oil prices, for instance the five-year, five-year forward in Europe,” said Chris Scicluna, head of economic research at Daiwa Capital Markets.

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

Additional reporting by Dhara Ranasinghe; Editing by Janet Lawrence

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