October 8, 2019 / 11:12 AM / 12 days ago

UPDATE 2-Portugal's 10-year bond yield falls to five-week low, below Spain's

(Adds German court case against asset purchases, Greek bond details, announcement of Italian dollar bond)

By Dhara Ranasinghe

LONDON, Oct 8 (Reuters) - Portugal’s 10-year bond yields hit five-week lows on Tuesday on expectations that the Socialist party would swiftly form a new government after its election victory at the weekend.

News of an unexpected jump in German industrial production in August initially pushed up yields across the euro zone, but the move proved short-lived amid uncertainty over Brexit and this week’s U.S./China trade talks.

Analysts said expectations for policy continuity in Portugal had boosted demand for the country’s assets.

Though the Socialists won Sunday’s election, they fell short of a full parliamentary majority, so their leader, Antonio Costa, prime minister for the past four years, needs to negotiate a new deal with one or both of his far-left allies in the previous legislature.

In a further boost for Lisbon, DBRS upgraded its credit rating upgrade for Portugal on Friday to BBB.

Portugal’s 10-year bond yield fell to as low as 0.111% , dropping below its Spanish equivalent, which traded at 0.13%. It was down 2 basis points on the day.

Portugal’s 10-year bond yield gap over top-rated Germany narrowed to as little as 65 bps, within sight of July’s lows .

“There’s a lot of upside news for Portugal, and the market believes the new government will follow the same policies as the previous one,” said Matt Cairns, fixed income strategist at Rabobank.

“There’s also a feeling of now being a good time to buy Portuguese bonds before the European Central Bank starts buying bonds again,” he said, referring to ECB asset purchases due to begin in November.

Most 10-year euro zone bond yields were down 2 to 3 basis points on the day.

On Monday, U.S. and Chinese deputy trade negotiators began two days of talks before the first minister-level negotiations in months on Thursday and Friday.

But markets were wary after Washington blacklisted eight Chinese tech companies and President Donald Trump suggested a quick deal to end the trade dispute was unlikely.

The latest Brexit headlines also boosted demand for safe-haven debt while pummeling the pound.

A Brexit deal is essentially impossible, a Downing Street source said on Tuesday, because German Chancellor Angela Merkel told Britain’s Prime Minister Boris Johnson that to reach one Northern Ireland must stay in the EU customs union.

Britain’s 10-year bond yield fell 3 bps to 0.42% , leaving the gap over German Bund yields near its tightest since late March at around 100 bps.

“There’s bond-positive sentiment in general today as we head into trade war talks, and there’s not much optimism about a possible deal,” said DZ Bank rates strategist Rene Albrecht.

Greece sold 1.5 billion euros of 10-year bonds via a syndicate of banks. The deal, a re-opening of a 10-year bond issued earlier this year, priced at a 1.50% yield.

Italy is next in line, announcing its long-awaited dollar deal, which will price on Wednesday. In its first dollar deal in nine years, Italy is selling five, 10 and 30-year bonds via a syndicate of banks.

Meanwhile, a group of conservative German academics sought on Tuesday to reopen hearings in a court case against the ECB’s new quantitative easing programme.

The European Union’s top court last year approved the ECB’s previous bond-buying programme.

Reporting by Dhara Ranasinghe; additional reporting by Yoruk Bahceli, editing by Larry King and Gareth Jones

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