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Euro zone bond yields creep higher as ECB looms

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03/08/2018 | 12:16pm CEST
FILE PHOTO:Illustration photo of U.S. Dollar and Euro notes

LONDON (Reuters) - Borrowing costs in the euro area nudged up on Thursday, before a European Central Bank meeting that could mark a tentative step by policymakers towards exiting an ultra-loose monetary policy.

The ECB is expected to keep its policy unchanged but, against a stronger economic backdrop, could signal a move towards ending its 2.55 trillion euro ($3.16 trillion) asset purchase scheme later this year.

Having promised to review their communication stance in early 2018, and with asset purchases due to end in September, the ECB could give investors at least a few hints to prepare them for a broader revision of policy in coming months.

"Thursday's ECB meeting ... could contain some very subtle hints that the end of quantitative easing is close," said Craig Erlam, senior market analyst at OANDA.

Most euro zone bond yields crept up, with Germany's benchmark 10-year yield 1 basis point higher at 0.67 percent <DE10YT=RR> -- above Monday's five-week low of around 0.60 percent.

Data showing German industrial orders fell by 3.9 percent on the month in January had little impact, with investors mostly sidelined ahead of the ECB.

Bond yields, which started the year sharply higher on expectations of an imminent shift in the ECB's policy stance, have drifted back down.

Low inflation, which hit a 14-month trough in February, has tempered market expectations for an ECB rate rise coming sooner rather than later.

A key market gauge of long-term euro zone inflation expectations <EUIL5YF5Y=R> this week dipped below 1.7 percent to its lowest level this year, while the euro's exchange rate against the currencies of the bloc's main trading partners on Wednesday rose to its highest level since 2014 <EUREER=ECBF>.

Currency strength puts downward pressure on inflation, making it harder for the ECB to achieve its near 2 percent inflation target.

To view a graphic on Trade-weighted euro vs inflation expectations, click: http://reut.rs/2D9MwsU

More recently, fears about a global trade war and political uncertainty in Italy after an inconclusive election could encourage the ECB to go slow in removing monetary stimulus.

Still, Kjersti Haugland, chief economist at DNB Bank, said she did not think trade war fears would impact Thursday's ECB meeting.

"There is a lot of noise and speculation but they will want to watch how things develop. If there are ripple effects then it will influence growth forecasts and the way they conduct their policy," she said.

The ECB announces its policy decision at 1245 GMT, followed by ECB President Mario Draghi's news conference at 1330 GMT, which will include the ECB's latest economic projections.

Money markets continued to price in a 10 basis point rate rise in early 2019, although expectations for a hike as early as this December have been scaled back. <ECBWATCH>

To view a graphic on Money markets bring forward bets on timing of ECB rate hikes, click: http://reut.rs/2D438SS

(Reporting by Dhara Ranasinghe; Additional reporting by Sujata Rao; Editing by Catherine Evans)

By Dhara Ranasinghe

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