* Ruling on stimulus scheme sparks doubts over ECB policy
* Southern European bond yields jump, spreads widen
* Euro set for biggest one-day drop in over a month
(Adds latest news, new comment and updates prices)
By Dhara Ranasinghe and Olga Cotaga
LONDON, May 5 (Reuters) - Southern government bonds lost
ground on Tuesday, pushing yields higher, after Germany's top
court ruled that the Bundesbank must stop buying bonds under the
European Central Bank's stimulus scheme if the ECB cannot
justify the purchases.
The ruling that Germany's central bank must end the
government bond purchases within three months unless the ECB can
prove they are needed clouds the bloc's monetary policy outlook
at a time when the coronavirus is hammering economic growth.
The decision did not apply to the ECB's PEPP coronavirus
pandemic-fighting programme, a 750 billion-euro ($812 billion)
scheme introduced in March at the height of a
coronavirus-induced financial market rout.
But the ruling raised concern about further expansions in
ECB asset purchases. That manifested in a sharp selloff in
Italian government bonds, pushing yields nearly 20 basis points
to a week-and-a-half high of 1.947% IT10YT=RR and leading the
gap over safe-haven German Bund yields to 251 bps, the widest in
around a week and a half DE10IT10=RR .
"The good news is that the ruling does not seem to apply to
the PEPP, but there is a bigger concern that it limits the
ability of the ECB to `do whatever it takes'," said Sarah Hewin,
chief Europe economist at Standard Chartered.
Since then, Italian yields have subsided, after German
Finance Minister Olaf Scholz said the ruling by Germany's top
court on the ECB's bond-buying programme allows the bank to make
such purchases in principle and the Bundesbank can continue to
take part for now. Italian 10-year yields were last up 15 bps at 1.903%.
"I would expect that from the SPD (Social Democratic Party
of Germany, of which Scholz is a member), but it's now whether
the Conservatives would share that view as well ... then I would
expect more of a market impact," said Peter Chatwell, head of
rates strategy at Mizuho.
Chatwell added that even though PEPP was not the topic of
this particular decision, "I think we can infer from this
decision that if there was to be a decision about the pandemic
programme, then it would be unlikely to be supported."
Amassing nearly 3 trillion euros of bonds since 2015, the
ECB has long relied on asset purchases to support the euro zone
economy through crises and the threat of deflation.
The court's ruling hit other European assets as well,
sending the euro down to a six-day low of $1.0826 EUR=EBS ,
setting it for its biggest daily drop in more than a month. The
common currency was last down 0.3% at $1.0864.
Among stocks, the pan-European index .STOXX cut some of
its gains following the ruling and was up 1.8%. German shares
.GDAXI briefly touched lows for the day. Euro zone banks
.SX7E halved their gains and were up 1.4%.
Other southern European countries' debt also took a hit,
with Spain's 10-year bond yield gap over Germany widening to 145
bps DE10ES10=RR , up around 8 bps from late Monday levels.
Spanish 10-year government bond yields were last up 2 bps at
0.851% ES10YT=RR
As the selling pressure in peripheral bonds gathered pace,
investors moved back into German bonds, allowing that market to
recover from a sell-off after the court ruling. The 10-year Bund
yield was last down 1.1 bps at -0.57% DE10YT=RR .
"The court ruling highlights that core countries not only
face political hurdles to any form of liability sharing but also
legal hurdles," said Richard McGuire, head of rates strategy at
Rabobank.
ECB policymakers will discuss the ruling at a Governing
Council meeting starting at 1600 GMT, a spokesman for the bank
said.
($1 = 0.9234 euros)
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