Bonds: Upcoming ECB policy meeting in focus

These were the movements in the most widely-followed 10-year sovereign bond yields:

US: Holiday

UK: 0.72% (-1bp)
Germany: -0.05% (-1bp)
France: 0.24% (+5bp)
Italy: 1.16% (-1bp)
Spain: 1.01% (-2bp)
Italy: 1.16% (-1bp)
Portugal: 3.05% (+1bp)
Greece: 8.13% (+3bp)
Japan: -0.33% (+0bp)

Sovereign bond markets edged higher for the most part, albeit with some notable exceptions, with Gilts largely brushing off a much-better-than expected reading on UK service sector activity during the month of August.

Investors in Sterling assets also appeared unconcerned by President Obama´s indication at the G-20 summit that his country´s first priorities were getting the Trans-Pacific Partnership and Transatlantic Trade and Investment Partnership trade deals done.

Against that backdrop, French bonds underperformed by a wide margin after IHS Markit´s service sector purchasing managers´ index for the euro bloc´s second largest economy in August was revised higher, from a preliminary reading of 52.0 to 52.3.

Meanwhile, a sharp downward revision to the German composite PMI for August, from 54.5 to 53.3, helped Bunds.

"A slowdown in the eurozone’s largest economy is clearly not good news for bloc as a whole, especially when some of the other economies, such as Italy, are not performing as well as they were in late 2015 and early 2016. Admittedly, the French composite PMI rose in August, but at 51.9, was still only consistent with GDP growth of just 0.1-0.2%," said Clemente De Lucia at BNP Paribas.

Ten-year debt issued by Lisbon was also slightly lower in price, nudging yields higher.

Ahead of the European Central Bank´s policy meeting on the following Thursday, the latest monthly ECB data revealed that purchases linked to quantitative easing were reduced to €60bn in August from roughly €85bn in July, with purchases of Irish and Portuguese debt still running well below what their respective 'capital keys' might lead one to expect, according to Danske Bank.

"The slowdown relative to other sovereigns is due to the issue/issuer limit," Danske Bank´s Anders Moller Lumholtz and Matthias Ron Mogensen said in a research note sent to clients.

The ECB data also revealed that purchases of French debt had seen the largest reduction (Ireland and Portugal aside) over the past five months, and compared to the first quarter of 2016, albeit by a small margin.

Looking out to Thursday´s ECB meeting, Citi´s Guillaume Menuety told clients: "The Governing Council is not closer to being able to demonstrate convincingly that its current policy settings are compatible with headline inflation returning to target by the end of the forecast horizon."

Menuety forecast the ECB would extend its asset purchase programme for "at least" another six months, modify its modalities of QE to avoid any "scarcity issues" and cut the refinancing rate to -0.10%, followed by a ten basis point reduction in the deposit rate to -0.5% in March 2017.

Economists at Barclays Research were of a largely similar view, although recent comments from some ECB officials had given them pause for thought.

"Recent statements from ECB members (Praet and Coeuré) seem to suggest that the bank prefers national governments to take the lead through the implementation of growth-friendly fiscal policies and structural reforms to support domestic demand in the short term and enhance growth potential. However, we remain sceptical that governments have sufficient fiscal leeway and political capital to do so in size," Barclays said in a research note sent to clients on 2 September.

Yields on Japanese 30-year sovereign debt advanced two basis points to 0.54% even after Bank of Japan Governor Haruhiko Kuroda told an audience on 4 September that the central bank still had "ample room" to ease policy.