UPDATE 2-Eurozone returns, inflation fears subside as energy prices fall

(New everywhere, updates prices, yields, market activity, adds ECB minutes)

October 7 (Reuters) – Eurozone bond yields fell on Thursday as energy prices held below recent highs, easing inflation fears and allowing debt markets to recover from the sharp drop from the previous session.

On Wednesday, gas and oil prices soared and bonds sold off. Yields, which move in the opposite direction to prices, have risen sharply, fearing that price increases will fuel already high inflation.

But gas and oil prices fell after comments from Russian President Vladimir Putin and an unexpected increase in US crude inventories.

Bond investors also breathed easier as Democrats in the U.S. Senate said they could agree to a Republican proposal to defuse the deadlock that threatened a U.S. debt default this month.

The 10-year German Bund yield fell 1 basis point for the last time to -0.19%, below the highest since late June of -0.147% reached on Wednesday.

Italian bonds, which underperformed Wednesday, outperformed Thursday. Ten-year yields fell 4.5bp to 0.85%, pushing the yield spread with German peers to around 104bp, from Wednesday’s one-week high of 108bp.

A key market indicator of euro inflation expectations fell to 1.7633%, the lowest for more than a week and some 10 basis points below the seven-year highs hit on Wednesday.

Falling energy prices have helped stabilize bond markets, but, “ultimately through this noise we think rates are going up,” said Antoine Bouvet, senior rate strategist at ING.

Bouvet underlined the risks associated with the hawkish turns of the US Federal Reserve, the Bank of England and the European Central Bank.

Last month, ECB policymakers debated a deeper reduction in asset purchases and harbored greater inflation fears than their post-meeting communication suggested, according to records of the September 9 discussions. .

“We agree that the recent strength in inflation has shifted the balance of risk upwards,” said Jack Allen-Reynolds, senior economist Europe at Capital Economics.

Isabel Schnabel, a member of the ECB’s board of directors, said inflation could remain high next year.

Emphasis was also placed on a Bloomberg News report citing sources that the ECB is considering a new bond-buying program to avoid market turmoil when its emergency bond-buying program in pandemic case (PEPP) will expire next year.

Any new program would replace the PEPP as well as the ECB’s conventional bond purchases and circumvent the rules governing how much of each country’s debt the ECB would buy, the report said, adding that no decision has been made.

“It is no coincidence that he is now coming out before a very important (political) meeting in December,” said Bouvet of ING.

There was little market reaction to the report, but Bouvet said the parameters of any new program would be critical.

Elsewhere, Spain and France raised medium- and long-term bonds at auctions. (Reporting by Yoruk Bahceli; Additional reporting by Dhara Ranasinghe; Editing by Alison Williams, Toby Chopra and David Gregorio)

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