EURO GOVT-Nerves over Cyprus bailout lift German Bunds

Fri Apr 12, 2013 7:35am EDT

Related Topics

* Cyprus to top EU finance ministers' meeting

* Island's bailout costs seen higher than expected

* Italy, Spain yields edge up on profit-taking

By Emelia Sithole-Matarise

LONDON, April 12 (Reuters) - German Bunds rose on Friday and are expected to gain more in the coming sessions as investor concern that Cyprus may need more bailout funds lifted demand for low-risk debt.

Cyprus's rescue package will top an informal meeting of European Union finance ministers starting later in the day.

Reuters obtained documents this week showing that the Mediterranean island will have to contribute almost twice as much as initially thought to its rescue package.

Adding to market edginess, Luxembourg Finance Minister Luc Frieden said Europe and the International Monetary Fund could not increase their 10 billion euro contribution to the Cyprus bailout depite news the cost was going to be higher than expected.

Cyprus and the European Union have agreed in principle how it will provide its 13 billion euro contribution to the bailout package, although that is almost twice the original figure due to the country's sharp recession.

"This is a lot more onerous for Cyprus, and I don't think they will get any concessions. They are talking about selling gold reserves, about privatisation, increasing capital gains taxes and all kinds of ways to raise the money," a trader said.

The Bund future was 55 ticks up on the day at 145.80, with German 10-year yields 4 basis points down at 1.263 percent, leaving it just 6 basis points from 8-month lows hit last week.

Bunds, favoured by investors as a safe-haven in times of market stress, were also seen supported by expectations that U.S. retail sales numbers due later in the day could undershoot forecasts after a recent rash of downbeat data.

"There are some short-term players who think the correction in Bunds is over and that the (U.S.) retail sales this afternoon will be weaker than expected. Also equities have done well but at the end of the week there might be some temptation to take profits there," said Piet Lammens, a strategist at KBC.

LOOKING TO JAPAN

In lower-rated euro zone bonds, Italian and Spanish bond yields edged up as concerns over Cyprus prompted some in the market to book profits in riskier assets, including equities, after their recent rally.

Italian 10-year yields were 3 basis points up on the day at 4.36 percent with Spanish equivalents up 4 bps at 4.71 percent.

The rise in yields was, however, seen as limited in the near-term by improved demand for riskier assets on the back of Japan's huge stimulus plans and increased bets that the European Central Bank will ease monetary policy in the coming months.

Questions over how much Japanese switching out of their ultra low-yielding domestic debt into non-yen denominated assets offering higher returns was tempering some of the euphoria that drove the yields of top-rated euro zone issuers such as France and Belgium to record lows this week.

"There's been no follow-through in terms of the flow out of Japan so people are questioning now the impact the BOJ policy may have so we are taking back a little bit of the hype out of the market and we may see yields go up a bit," said Alessandro Tentori, global head of rates strategy at Citi.

Although anticipation of flows from Japan into the currency bloc also benefited lower-rated bonds, some analysts are sceptical that they will actually switch from their domestic bonds into riskier paper from the likes of heavily-indebted Italy, struggling to form a government after February elections.

"When it comes to the banks and pension funds it's unlikely that they will all of a sudden go into Spain and Italy. France is likely to remain one of the favourites," Tentori said.

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