Euro zone bonds tread water with focus on ECB meeting

By Alun John

LONDON, April 27 (Reuters) - Euro zone short-dated government bond yields were little changed after wavering earlier on Monday, as no major weekend developments in the U.S.-Israeli war with Iran left traders to focus on this week's European Central Bank meeting. While policymakers are expected to keep interest rates steady on Thursday, investors will be scrutinising their statement and ECB President Christine Lagarde's press conference for any expectations for the euro zone economy and what policy response might be appropriate. Markets currently see roughly a 20% chance that the ECB hikes rates by 25 basis points this week, around a 75% chance it does so by its June meeting and expect at least one such move and potentially two by the July meeting. That pricing on Monday was similar to Friday, helping Germany's two-year yield trade flat on the day at 2.56%. Germany's benchmark 10-year yield meanwhile was a whisker higher at 3.024%. Before the war, markets expected the ECB to be on hold throughout this year, but traders dramatically reassessed those expectations in March, betting that policymakers would feel obliged to raise rates to prevent higher energy costs from spilling over into inflation more broadly.

This week's meeting will give investors their latest insight into the ECB's thinking.

"If the ECB signals that June is 'live', front-end yields could move higher. However, a more cautious tone appears more likely, reinforcing patience and limiting the extent to which markets price in additional tightening," said Annalisa Piazza, fixed income portfolio manager at MFS Investment Management.

She said that as financial conditions were already tightening and growth concerns mounting, "the ECB is unlikely to encourage expectations of multiple near-term hikes". This stance, she said, could send shorter-dated yields lower. Potentially offering some support to the view that rate-setters can afford to be a bit cautious with rate hikes, anECB survey published on Monday showed that while euro zone firms expect inflation to surge in the near term on the Iran conflict, longer-term bets remained steady and wage growth is expected to moderate. Other countries' bonds were moving in line with the benchmark. Italy's two-year yield was also flat at 2.794%, although its 10-year yield was 2 bps higher at 3.837%.

In addition to the ECB meeting, traders also will be watching a number of other major central banks. The Bank of Japan announces its policy decision on Tuesday, the Federal Reserve releases its statement on Wednesday and the Bank of England will make its announcement on Thursday.

All are expected to keep rates steady. (Reporting by Alun John; Editing by Thomas Derpinghaus, Emelia Sithole-Matarise and Paul Simao)