April 28, 2020 / 10:23 AM / a month ago

UPDATE 2-Italian bond yields fall but hold near two-week highs

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Elizabeth Howcroft

LONDON, April 28 (Reuters) - Italian government bond yields continued to fall on Tuesday, reflecting investor relief that the country had avoided a ratings downgrade and had laid out plans to re-open the economy, even as analysts expressed caution about the outlook.

Demand for Italian debt has been rising since Friday, when rating agency S&P held Italy’s credit rating at two notches above “junk”, even though the country expects to be among the worst hit by the coronavirus in Europe.

The Italian government has since laid out plans for a cautious re-opening of the economy.

DZ Bank rates analyst Rene Albrecht said the two factors were behind the extended fall in Italian bond yields but added that the attractiveness of Italian debt to investors is limited.

“We are not that bullish on BTPs (Italian government bonds), we still see potential for spread widening because of the trouble getting a consensus in Europe on how to help the most troubled countries,” he said.

“And of course the starting point for Italy before the coronacrisis was the worst of all the European countries. They had the highest debt and the lowest growth... So of course there is some caution among investors because they were on the troubled path before and now this path won’t get any easier.”

Italy’s 10-year government bond yield fell as much as 6 basis points to hit fresh two-week lows and was last down 3 bps on the day at 1.72%.

The spread between German and Italian 10-year government bond yields contracted to its narrowest in nearly two weeks and was last at 218 bps, down more than 50 basis points from last week’s peak..

The rally spread across the peripheral market, with Spanish and Portuguese ten-year government bond yields holding near weekly lows .

Rabobank rates strategists wrote in a note to clients that this represents a selling opportunity, as optimism off the back of hopes of lockdowns being lifted and the decisions of ratings agencies is misplaced.

“The pricing in of a “V-shaped” recovery is hugely overly optimistic,” they wrote.

Elsewhere, the benchmark German government bond yield was 3 bps lower on the day at -0.47%.

Major central banks have responded to the economic slump caused by the coronavirus by slashing interest rates, buying more government debt, and taking steps to increase lending to small companies.

The European Central Bank (ECB) meets on Thursday and is expected to expand its emergency debt purchases soon. It may also consider including junk bonds in its asset purchase programme, some analysts said.

“The likelihood is that the ECB will further step their firepower up in order to continue to support the weakest elements of the bloc,” Mizuho rates strategists wrote in a note to clients.

“Additional ECB easing...will most likely come in the form of broadened or enlarged asset purchases,” they said.

The ECB’s bank lending survey showed on Tuesday that euro zone banks recorded a surge in emergency credit demand from corporate clients in the first quarter and a further rise is likely as the coronavirus pandemic batters the economy.

Reporting by Elizabeth Howcroft; Editing by Christopher Cushing, Kirsten Donovan

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