* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts, adds details, comments)
By Yoruk Bahceli and Dhara Ranasinghe
LONDON, July 16 (Reuters) - Italian government bond yields fell to their lowest since late March on Thursday as the ECB reassured markets it will most likely use the full firepower of emergency bond purchases to tackle the economic hit from the coronavirus pandemic.
The ECB kept monetary policy on hold, but remains on track to buy up to 1.35 trillion euros worth of debt through next June under its Pandemic Emergency Purchase Programme (PEPP), and up to 1.8 trillion euros if other purchases are also included.
ECB chief Christine Lagarde said that unless there are significant positive surprises, the bank’s base line case is that the emergency purchase “envelope” would be used in full.
That pushed Italy’s 10-year bond yield to its lowest since late March, at 1.245%. Lagarde’s comments brought comfort after recent suggestions from ECB board members that the entire PEPP “envelope” might not be spent, coupled with a slowdown in weekly bond purchases, had raised concern.
“It is reassuring enough for markets and left the door open to more stimulus,” said Antoine Bouvet, senior rates strategist at ING in London.
Emergency bond purchases have been crucial to stabilising markets and narrowing the risk premium that highly indebted, lower-rated Southern European sovereigns pay on top of German debt, which shot up in March when the coronavirus-panic gripped markets.
“The base case in markets now is that the commitment to PEPP is high enough that investors will be encouraged into summer carry trades,” ING’s Bouvet said, referring to transactions where investors borrow at low interest rates and invest in higher-yielding assets like Southern European government bonds.
German government bonds also rallied, with the 10-year benchmark falling to its lowest in nearly a week at -0.47% .
With no change to ECB policy expected, the euro also held steady. European stocks barely budged, with both the broader pan-European index and banks stocks remaining in negative territory.
Michael Hewson, chief market strategist at CMC Markets, said the meeting was “just a copy-and-paste of the last meeting”, where the ECB upsized the emergency bond purchase programme.
The onus is now on European Union leaders to agree on a 750 billion euro recovery fund, Hewson added, though he didn’t expect an agreement at the EU summit beginning Friday.
Some had expected an increase to the amount of excess bank reserves that are exempt from being charged the -0.50% deposit rate, which helps offset the impact of negative rates on the banking sector. But Lagarde said she saw no reason for change.
“Increasing the tiering multiple remains a policy option... That is something for markets to think about,” said Marchel Alexandrovich, European financial economist at Jefferies.
Reporting by Yoruk Bahceli, Dhara Ranasinghe and Elizabeth Howcroft; additional reporting by Julien Ponthus, Olga Cotaga; editing by Mark Heinrich