Euro zone bond markets turn to ECB as coronavirus shakes markets, hits economy

* ECB expected to deliver easing package

* Trump bans travel from Europe, rattles markets

* Yields, inflation expectations near record lows

* Euro zone periphery govt bond yields

By Dhara Ranasinghe

LONDON, March 12 (Reuters) – Government bond yields in much of the euro area fell on Thursday, before a European Central Bank meeting widely expected to deliver new stimulus measures to help buffer the economy from the shock inflicted by the coronavirus outbreak.

The virus, now officially a global pandemic, has sparked a lockdown in Italy, triggered turmoil across world markets and dealt a fresh blow to a weakened euro zone economy.

News that U.S. President Donald Trump has banned travel from Europe knocked risk assets on Thursday, pushing yields on safe-haven government bonds in the euro zone down 2 to 3 basis points in early trade.

Germany’s 10-year Bund yield fell to -0.78%, keeping Monday’s record low in sight. Italian bonds sold off with other risk assets, pushing 10-year bond yields there up around 7 bps to 1.26%.

Trade was subdued ahead of the ECB meeting. It comes a day after the Bank of England delivered an emergency half-point rate cut. The U.S. Federal Reserve slashed rates last week in an unexpected move to guard its economy against coronavirus.

The ECB is expected to provide new, ultra-cheap loans for banks to pass onto small and medium-sized firms. It is also likely to debate an interest rate cut, though that move is uncertain.

“The ECB meeting will be hugely important, but it’s very difficult to call what kind of easing is likely,” said Ross Hutchison, rates fund manager at Aberdeen Standard Investments. “A rate cut is plausible … but I don’t see that as an effective policy option.”

Analysts said a collapse in euro zone market inflation expectations – exacerbated by a crash in oil prices – also raises pressure on the ECB to ramp up monthly asset purchases, currently at 20 billion euros.

The five-year, five-year breakeven inflation forward, has fallen to record lows below 1%, a sign that investors are starting to price in deflation risks.

The rush to own top-rated German bonds, amid heightened uncertainty meanwhile, has pushed up relative borrowing costs for other euro zone states.

In Italy, the centre of the coronavirus outbreak in Europe, the 10-year bond yield gap over Germany on Monday blew out 50 bps — the biggest one-day spread widening since May 2018.

Other sovereign bonds spreads over Germany have widened in what analysts say is a worrying sign for the ECB.

“We would suggest that an expansion of QE (quantitative easing) is, to some extent but far from fully, priced and so a lack of an announcement today will likely see sovereign spreads widen,” said Rabobank rates strategist Lyn Graham-Taylor.

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