April 29, 2019 / 7:40 AM / 25 days ago

UPDATE 3-Spanish bonds strengthen after "pro-European" election result

* Spain’s Socialists look set for government return

* Spain/Germany bond yield gap tightens sharply

* U.S. consumer spending increases by most in 9-1/2 years

* S&P affirms Italy’s BBB rating, two notches above junk

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates pricing, adds detail on US consumer spending)

By Abhinav Ramnarayan

LONDON, April 29 (Reuters) - Spanish government bond yields dipped on Monday after the weekend’s general election in which the Socialists emerged as the strongest party, a result seen by many in the market as pro-European.

Spanish Prime Minister Pedro Sanchez portrayed the result as a morale booster for the European Union as he looks set to regain power after his Socialists overcame a historic challenge by right-wing nationalists in Sunday’s vote.

Coalition talks are set to begin this week, but market participants anticipate a coalition of left-leaning parties to take power in Spain as the most likely outcome.

“When you compare this to our worst fears for Europe, this is the most pro-European voting result you could have had,” said Marie Owens Thomsen, global head of economic research at Indosuez Wealth Management.

“But also these parties are the more conciliatory to separatist forces, so I suspect Catalonia is going to remain an issue for the foreseeable future,” she said, referring to the thriving independence movement in the northeastern province.

Spain’s 10- and 30-year bond yields, having dropped in the run-up to the vote on the back of pre-election polls, were down about two basis points on Monday.

Spain’s bond yield spread over Germany was at its tightest level in nearly two weeks at 100 basis points and well off last week’s highs of 110.6 bps.

The spread is heading towards the 95 bps mark which matches the tightest levels this year reached in early March.

Spanish government bonds have been one of the strongest performing in the region over the past two years as the country’s impressive economic growth has pushed up its credit rating to the Single A category from two of the three main ratings agencies.

Better than expected U.S. consumer spending data briefly nudged up the safe haven 10-year German Bund yield to a session high of 0.017 percent. It was last up around two basis points at zero percent.

Other better-rated euro zone government bond yields rose 1-2 bps on the day.

“The silver lining for Spain continues to be growth,” Barclays said in a note.

“In 2019, Spain will still outperform other large euro-area economies Germany, France and Italy. Therefore, we think that markets will not react very negatively to the political uncertainty in the weeks ahead.”

Elsewhere, an early rally in Italian bonds — triggered by S&P Global’s decision on Friday to maintain the country’s sovereign credit rating two notches above junk — proved short-lived.

Italy’s 10-year bond yield was flat at around 2.58 percent, having dropped as much as five basis points to 2.53 percent in early trade.

Later in the week, inflation numbers for the euro zone, a U.S. Federal Reserve meeting and business surveys in Italy and Spain could all have an impact on markets.

Reporting by Abhinav Ramnarayan, Editing by Karin Strohecker, Ed Osmond and Kirsten Donovan

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