European govt bonds remain lower as risk appetite picks up

LONDON (Thomson Financial) - European government bonds remained lower as risk appetite picked up, with equities rising and bonds losing some of their safe haven appeal, though trade was nervous ahead of Thursday's interest rate decisions in Europe and the UK.

With the US closed for the Labor Day holiday, investors are continuing to digest Friday's comments by Federal Reserve chairman Ben Bernanke and US President George W Bush, which helped to restore some calm to financial markets.

"It's still very much a question of the level of risk appetite. Bernanke and Bush reassured everyone and investors are a little more comfortable with risk at this stage - equities have picked up and bonds are losing a little of their safe haven appeal," said Audrey Childe-Freeman at CIBC World Markets.

Bernanke told the annual monetary policy symposium in Jackson Hole on Friday that the Fed is ready to "act as needed" to prevent the credit crisis from spilling through into the wider economy, sparking hopes for a cut in interest rates to follow the recent reduction in the deposit rate.

Bush then announced a plan to help borrowers facing trouble paying their mortgages.

Markets remain nervous, however, ahead of Thursday's interest rate decisions, Childe-Freeman noted.

Both the ECB and the BoE are forecast to leave interest rates unchanged given the recent turbulence on financial markets. Both had previously been broadly expected to deliver quarter point rises prior to the credit crisis.

The BoE, however, is unlikely to release a statement to accompany the decision and focus will centre on ECB president Jean-Claude Trichet's accompanying press conference.

Trichet will have to backtrack after previously signalling a rate hike through his reference to the need for "strong vigilance" on inflation risks, though the focus will centre on whether or not he signals that interest rates are still likely to rise.

"Another omission of 'strong vigilance' in the comments this week may be interpreted as though the Bank is prepared to delay a hike indefinitely, if indeed it hikes at all," said Calyon fixed income analyst Orlando Green.

Even in this scenario, however, the ECB could still indicate a further hike in between its press conferences, though this would be "subject to healthier market conditions".

Over in the UK, gilts were also lower and slightly underperforming their European counterparts after a survey showed manufacturing activity in the UK surged to its highest rate in over three years.

UK manufacturing PMI jumped to 56.3, its highest level since June 2004, while July's reading was revised to 55.9 from 55.7 previously, well above expectations for a fall to 55.0.

Today's numbers are unlikely to alter expectations that the Bank of England will leave interest rates unchanged at Thursday's meeting given recent market uncertainty and weak inflation numbers in July, though it may increase the chances of an interest rate rise some time over the months to come.

"The overall strong tone of the manufacturing survey is a reminder that the UK economy is still performing pretty well overall at the moment, and that an eventual further interest rate hike is still very possible despite the current turmoil in global credit and financial markets," said Howard Archer at Global Insight.

Among other data released today, the euro zone's PMI index on manufacturing activity for August was revised up to 54.3 from 54.2 in the provisional estimate but remains down on the 54.9 recorded in July. The revision still leaves the index at its weakest for over a year and a half.

At Yield Change on

1554 BST pct previous close

Sept euribor future (Liffe) 95.32 dn 0.04

Dec euribor future (Liffe) 95.47 dn 0.04

GERMANY

Sept bund future (Eurex) 113.49 dn 0.28

3.75 pct Jul 2017 govt bond 99.77 4.27 dn 0.30

FRANCE

3.75 pct Apr 2017 govt bond 95.24 4.36 dn 0.27

ITALY

4.00 pct Feb 2017 govt bond 96.25 4.54 dn 0.25

UK

Sept gilt future 106.64 dn 0.36

4.00 pct Sept 2016 govt bond 92.24 5.08 dn 0.37

Sept short sterling future 93.37 dn 0.06

Dec short sterling future 93.64 dn 0.05

jessica.mortimer@thomson.com

jkm/slm