Euro zone yield curves steepen in nod to Japan policy shift

By John Geddie and Dhara Ranasinghe

LONDON (Reuters) - Long-term euro zone bond yields rose and curves steepened on Wednesday after the Bank of Japan set a long-term rate target and "curve controls" in a move seen as a shift away from money-printing.

But as investors questioned whether the policy shift would be effective in raising inflation expectations, and with the U.S. Federal Reserve adding to uncertainty with a policy meeting that concludes on Wednesday, the market moves were contained.

The BOJ held off deepening negative rates or expanding its asset purchase target on Wednesday, instead pledging to keep 10-year bond yields around current levels at zero and steepen curves in what could be a boon for the financial system.

"We had the initial market impact to the shift in policy and now there's a question over whether that shift can have the desired impact," said Orlando Green, European fixed income strategist at Credit Agricole.

In Germany - the bloc's benchmark debt market - 30-year yields initially rose as much as 4 basis points (bp) to 0.61 percent, while 10-year yields rose 2 bps to 0.01 percent and two-year yields were flat at minus 0.66 percent, having briefly fallen during the session.

The gap between two- and 10-year yields was near its widest in five months at 66 bps on Wednesday.

The economic benefit of steeper yield curves may come through the financial system, helping generate the inflation that central banks have promised to revive.

Banks make money by borrowing short-term funds cheaply and lending at higher rates over the longer term, while steeper curves help insurance firms and pension funds meet their long-term commitments.

Some analysts have begun to suggest that the European Central Bank may soon follow the BOJ's lead, although such changes could open a legal can of worms.

While the BOJ move was seen as stepping up its inflation drive, even committing to an overshoot of its elusive 2 percent target, some said more action would be needed.

"For it to succeed the public must believe that the BOJ can credibly raise inflation, something it has failed to do so far," said Keith Wade, chief economist at Schroders, adding that he expected the BOJ to cut its official interest rates at its Nov. 1 meeting.

Japanese 10-year bond yields rose to a six-month high near 0.01 percent, up some 7 bps on the day. They then fell back into negative territory in what traders said was a sign that investors would test the BOJ's commitment to its new target.

(Editing by Alexander Smith/Mark Heinrich)