* Peripheral bond markets underperform so-called “core”
* Spain faces tough govt talks after inconclusive vote
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds chart and analyst quote)
By Dhara Ranasinghe and Yoruk Bahceli
LONDON, Nov 11 (Reuters) - A selloff in southern European bond markets gathered pace on Monday, pushing yields higher, with an inconclusive election in Spain adding to uncertainty in its bond market.
Government bond markets across the single-currency bloc have been hurt in recent weeks by optimism over a U.S.-China trade deal and signs of stabilisation in economic data.
But Italy’s bond market, in particular, and to a lesser extent Spanish and Portuguese ones have borne the brunt of selling in recent sessions.
Analysts mainly attributed this to profit-taking on stellar gains in peripheral bond markets before year-end — Italian and Spanish 10-year bond yields are down 140 and 100 basis points respectively this year.
They also cited a growing sense that the bar for further European Central Bank stimulus is high, citing a Financial Times article reporting that new ECB chief Christine Lagarde is to face calls for an overhaul of how the ECB decides monetary policy.
That is seen as negative for peripheral bond markets, which have been strong beneficiaries of ECB asset purchases.
“The FT article adds to this notion that the ECB is reaching the limits of what it can do, rate cut expectations have faded and that helps explain the weakness in peripheral bonds,” said Rainer Guntermann, a rates strategist at Commerzbank.
While 10-year yields on higher-rated bonds such as German and Dutch ones were up about 2 basis points , 10-year yields across southern Europe rose much more.
Italy’s 10-year bond yield was 7 bps higher on the day at 1.35%, while its gap over Bund yields touched its widest level in over two months at around 161 bps. It was last at 158 bps.
The Italian 10-year yield has jumped 30 bps this month alone, compared to around 12 bps for French and German peers.
Investors are also being cautious while the European Union reviews Italy’s budget, said TD Securities rates strategist Pooja Kumra, after the EU’s rejection of the country’s budget last year rattled markets.
While the EU is not planning on rejecting Italy’s budget , it projects Italy’s debt to GDP ratio to increase to over 137% in 2021, unlike Rome, which expects it to keep falling until 2021.
In Spain, 10-year bond yields rose 3 bps to 0.43%, pushing the gap with its German peer to its highest level since mid-October at around 67 bps.
Spain’s acting prime minister, Socialist leader Pedro Sanchez, faced the prospect of hard bargaining to form a government on Monday after his gamble on holding the country’s second election this year resulted in no clear winner but a surge for the far right.
Political uncertainty has so far had a limited impact on Spanish bonds, which have been supported by a relatively firm economy although analysts warned of weakness ahead.
“The path to a coalition government is still unclear with this result,” said Peter Chatwell, head of rates strategy at Mizuho in London.
“We expect our trades geared towards Spanish weakness to perform, given the lack of election uncertainty premium that was priced into Spanish bonds.”
Federico Santi, senior analyst for Europe at Eurasia Group, said that a third consecutive election has now become more likely although it is widely seen as a last resort.
Reporting by Dhara Ranasinghe and Yoruk Bahceli; Editing by Simon Cameron-Moore and Ed Osmond