July 27, 2018 / 7:27 AM / 3 months ago

Dovish ECB underpins euro zone bond markets

* German Bund yield holds below 6-wk low on dovish ECB

* Most euro zone bond yields little changed

* U.S. Q2 GDP data awaited, BOJ in focus

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, July 27 (Reuters) - Borrowing costs in the euro zone’s biggest economy, Germany, held below six-week highs on Friday, a day after the European Central Bank’s president backed market expectations for a rise in interest rates late next year.

Most 10-year bond yields in the bloc were steady ahead of second quarter U.S. economic growth data that many economists expect to show a strong reading.

A note of unease also lingered ahead of Monday’s Bank of Japan meeting, which has taken on greater significance with recent reports that the central bank is debating moves to scale back its massive monetary stimulus.

For now, however, there was some comfort for euro zone bond markets from Thursday’s ECB meeting.

ECB chief Mario Draghi struck a relatively upbeat tone on the economic outlook, reaffirmed plans to end the bank’s 2.6 trillion euro stimulus programme this year and keep rates low “through the summer of 2019”.

Asked to unpack this formulation, which has given rise to diverging interpretations, Draghi said market expectations were “very well aligned” with the central bank’s own.

Money markets are pricing in a 10 basis point increase in the ECB’s minus 0.40 percent deposit rate in October 2019, in what would be the first hike since 2011.

“There was a dovish spin relative to what one could have expected, given a recent source-based story that some members of the governing council were not happy with the market pricing on rates,” said Christoph Rieger, head of rates at Commerzbank.

Germany’s 10-year Bund yield was flat at 0.40 percent , holding below almost six-week highs hit this week at 0.424 percent.

Two-year German bond yields also pulled back from six-week highs touched on Thursday at minus 0.5950 percent.

Most euro zone bond yields were set to end the week higher for a second week running, with 10-year bond yields in France and Germany up roughly 3 basis points on the week.

That reflects an easing in trade-war fears following talks between the United States and European Union this week and speculation that the BOJ is mulling policy tweaks of its own.

Japan’s 10-year government bond yield slipped off a one-year high on Friday after the BOJ conducted special, unlimited buying for the second time this week.

Most market players expect central bankers meeting on Monday to stop short of making immediate policy changes and to say instead that they will study ways to reduce the side-effects of the prolonged easing, such as hits to banks’ profits.

“The elephant in the room could be the BOJ, which is very hard to assess,” said Rieger.

Reporting by Dhara Ranasinghe

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