July 20, 2020 / 7:38 AM / 20 days ago

Italian bond yields fall to early March lows as potential for EU recovery fund deal grows

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Yoruk Bahceli

AMSTERDAM, July 20 (Reuters) - Italy’s borrowing costs fell to their lowest since early March on Monday as signs of a potential agreement started to emerge from a fraught European Union summit aimed at agreeing a 750 billion euro economic recovery fund.

The proposed fund, which envisions liability sharing in offering grants to the worst hit states, has been a key driver of a rally in Southern European bonds led by Italy since May, following an initial, similar Franco-German proposal.

The summit, originally scheduled for Friday and Saturday, stretched into Monday as fiscal hawk states led by the Netherlands balked at the size of grants to the worst affected states and demanded handouts be conditional on economic reforms.

But a deal this week looked possible after Bloomberg News reported that the “frugal” states were ready to accept 390 billion euros of the fund being offered as grants and the rest as loans - less than the 500 billion euros in grants the EU originally proposed.

Diplomats earlier told Reuters leaders might abandon the summit and try again for an agreement next month. The summit was adjourned on Monday until 1600 CET (1400 GMT).

After markets last week judged prospects of a deal being struck over the weekend increasingly unlikely, Italian bonds rallied on the latest optimism at the open of the session.

Italy’s 10-year yield fell to its lowest since March 9 at 1.19%, wiping out much of the coronavirus sell-off that drove them as high as 3%. It was last down 4 basis points on the day at 1.21%

That reduced the closely watched risk premium Italy pays for 10-year debt on top of Germany to its lowest since late March at 163 bps.

“It’s very very much material, meaning that there is going to be significant support going forward. But I think more important than the size of the package at the moment is the fund being implemented (at all),” said Peter Chatwell, head of multi-asset strategy at Mizuho in London, who expected an accord might be sealed later on Monday.

But Chatwell also warned that negative headlines around conditionality could undo some of the gains in later trade.

“If there are more rigid and unpalatable conditionalities, which relate more to stability and growth pact-type conditions, or conditions which are normally associated with a bailout deal, that would hit the breaks on positivity.”

Safe-haven German 10-year yields were up 2 basis points to -0.44%. (Reporting by Yoruk Bahceli Editing by Mark Heinrich)

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