EURO GOVT-Weak periphery, dovish ECB lift German Bunds

Fri Feb 8, 2013 4:31am EST

Related Topics

* Slightly dovish ECB tone underpin demand for Bunds

* Italy, Spain yields rise on nagging political concerns

* Irish bonds propped up after Dublin bank debt deal

By Emelia Sithole-Matarise

LONDON, Feb 8 (Reuters) - German Bunds continued to push higher on Friday after comments from the European Central Bank chief fuelled expectations the bank could be willing to cut interest rates if the euro continues to strengthen.

Nagging concerns about political stability in Spain and Italy were piling pressure on higher-yielding peripheral bonds to the benefit of Bunds, overshadowing an Irish bank debt deal that will cut Dublin's borrowing costs over the next decade.

The Bund future was last 23 ticks up on the day at 143.03 with German 10-year bond yields at 1.59 percent , down 2 basis points on the day.

German yields, led by two-year paper extended this week's falls after ECB President Mario Draghi said on Thursday that the ECB would monitor the economic impact of a strengthening euro, feeding expectations the surging currency could open the door to an interest rate cut. He also played down a rise in money market rates.

"Bunds had to go up after Draghi. He was pretty dovish. I don't think you can rule out a rate cut in the first half of the year and that should keep things underpinned," a trader said.

German two-year yields, which are the most sensitive on the curve to shifts in interest rate expectations, were 1.3 bps lower at 0.16 percent, around their lowest in two weeks. Some analysts expect further falls in coming days.

Among the euro zone's lower-rated bonds, Irish debt held steady, underpinned in the afterglow of Dublin's bank debt deal with the ECB that will reduce its borrowing costs over the next decade, putting it on course to exit its bailout programme.

The benchmark Irish 10-year yield was hovering around its lowest level since before the start of the subprime crisis in 2007, hit on Thursday on news Dublin had clinched a bank debt deal that will cut its borrowing needs over the next decade.

Analysts expected Irish debt to keep outperforming higher-rated Italian and Spanish bonds, whose recent sharp rally came to a halt this week on mounting concerns about political risk in the two countries.

Spanish 10-year yields were last at 5.42 percent while equivalent Italian yields were about 1 basis point up at 4.58 percent.

"On the 10-year Spanish bonds, we could go significantly above 5.50 percent and reach the 5.60 area and it can be quite fast and on the BTP 4.70-75 area could be reached as well," BNP Paribas strategist Patrick Jacq said.

"On a longer-term view we still expect market friendly outcomes of the political issues and the setbacks offer some opportunities to enter long positions."

In Spain, Prime Minister Mariano Rajoy was facing pressure to resign over a political scandal, in which he denies wrongdoing. In Italy, signs that former Prime Minister Silvio Berlucsoni's poll ratings were improving before elections in two weeks sparked concern his potential comeback to the centre of the country's politics could derail its austerity programme.

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