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Dovish ECB Draghi reinvigorate euro zone bond markets, euro slips

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LONDON (Reuters) - Euro zone government bond markets rallied and the euro slipped on Wednesday, after European Central Bank chief Mario Draghi warned that risks to the economy remained to the downside.

While equity markets also climbed initially, they gave back their gains on disappointment over the lack of details on a new round of cheap bank loans and the ECB’s mooted plans to offset the impact of negative interest rates on banks.

The ECB left its ultra-easy stance unchanged as expected and Draghi said economic data is weak and that the impact of country and sector-specific factors is longer lasting.

He confirmed that policymakers were considering if measures were needed to mitigate the impact on banks of its negative deposit rates as well as the pricing of new cheap two-year loans to banks, but said it was too early to decide.

“On balance, the lack of acknowledgment that the data might be improving was missing and that has been slightly bond-market-friendly,” said Peter Schaffrik, global macro strategist at RBC Capital Markets. “Draghi also reiterated that they have all options on the table.”

A rally in government bond markets that has stalled in the past week resumed, with yields falling as prices raced higher.

Germany’s 10-year bond yield fell to a one-week low of minus 0.039 percent — 5 bps away from 2-1/2 year lows hit last month. Five-year German bond yields were down 3 bps and set for their biggest daily drop in two weeks.

French 10-year bond yields also fell 3 bps, hitting their lowest level in almost two weeks at 0.31 percent.

Money market futures rallied as Draghi’s comments reinforced expectations that interest rates would remain lower for longer.

Talk of tiered rates in recent weeks has also led to some speculation that the ECB could cut interest rates. Eonia futures dated to the ECB’s December 2019 meeting price in roughly a 22 percent chance of a 10 bps rate cut. That compared to around 15 percent before Draghi began speaking.

Indeed, analysts noted Draghi’s comments also suggested market were right in their reaction to a speech two weeks ago when he said the ECB could further delay a rate hike and may look at measures to mitigate the side-effects of negative rates.

“Interestingly, Bund yields hit recent lows of -9 bps on this day which implicitly indicates that Draghi is validating the market pushing rate hikes further out which also helps explain Bund strength and euro weakness today,” said Mohammed Kazmi, portfolio manager at Union Bancaire Privee.

For a graphic on Markets react to ECB's Draghi, see -

The euro fell to a session low of $1.12295 and was last down 0.15 percent on the day.

In southern Europe, Italian bond yields came off their lows after Draghi said the ECB’s Governing Council did not discuss the terms of new cheap bank loans at Wednesday’s meeting, nor the pros and cons of mitigating measures.

Euro zone stocks also pulled back. Bank stocks were last down 0.65 percent.

“The cards were close to the chest for this announcement, and the reason probably is because they’re waiting for the announcement between (U.S. President Donald) Trump and (Chinese President) Xi,” said Gregory Perdon, co-chief investment officer at private bank Arbuthnot Latham.

Reporting by Dhara Ranasinghe, Virginia Furness, Abhinav Ramnarayan, Josephine Mason and Saikat Chatterjee; Editing by Tommy Wilkes and Catherine Evans

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