LONDON (Reuters) - High-grade euro zone government bond yields edged lower on Monday on expectations the ECB will this week maintain its ultra-loose monetary policy stance, while further headlines around French elections kept that country's bonds on the boil.
The European Central Bank meets on Thursday and is not expected to make any changes to its monetary policy, highlighting a divergence with the United States, where comments in the past week from Federal Reserve officials have seen expectations for a March rate hike ratchet higher.
Remarks by Fed chief Janet Yellen on Friday cemented the view that the Fed is likely to raise interest rates when it meets on March 14-15.
The ECB faces a balancing act between signalling that it will keep monetary policy stimulus in place as contentious Dutch and French elections loom, while at the same time acknowledging stronger economic growth in the region and higher inflation.
Data last week showed inflation in the 19-member euro zone rose to 2 percent in February, zooming past the ECB's inflation target of close to but below 2 percent.
Investors will watch ECB President Mario Draghi for any change in his forward guidance, paying attention to whether he will drop the reference to keeping interest rates at their "present or lower levels for an extended period of time".
"There is a remaining risk that on the rates guidance, the ECB becomes a little less dovish," said Commerzbank rates strategist Rainer Guntermann.
"The news flow on inflation has certainly been positive, but on the other hand there are risks in the euro zone so it's probably too early to say there will be a consensus on the need for policy tweaks."
Germany's benchmark 10-year Bund yield fell 1.2 basis points to 0.345 percent, off a two-week high hit on Friday.
Meanwhile, the French equivalent yield rose 1.4 bps to 0.97 percent, the gap between the 10-year bond yields of the two countries coming off the one-month low reached last Friday.
French bond yields rose after former French prime minister Alain Juppe said he was not prepared to be a candidate in the country's presidential elections.
Investors, worried that this made a victory by anti-EU leader Marine Le Pen more likely, also pushed the euro lower.
"There's so much uncertainty around the French elections, and investors are so used to treating French government bonds as a stable instrument in the past that they are now reacting to every headline," said Commerzbank strategist David Schnautz.
"The volatility in itself is pushing the (France-Germany) spread higher."
An opinion poll on Friday had suggested that if Juppe were to replace the beleaguered Francois Fillon as the centre-right candidate, he would win the first round of the election, with centrist candidate Emmanuel Macron coming second - a scenario that would knock Le Pen out of the race.
Against a backdrop of stronger euro zone data and talk of another U.S. rate rise soon, money markets price in around a 60 percent chance that the ECB will hike its deposit rate by 10 basis points early next year.
A tapering of the ECB's bond buying stimulus is seen as a key risk for government bond markets and analysts say talk of policy loosening is still premature.
Editing Ed Osmond