Euro zone debt inches up after German's Merkel wins vote

Mon Sep 23, 2013 3:47am EDT

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By Emelia Sithole-Matarise

LONDON, Sept 23 (Reuters) - Euro zone government bonds edged up on Monday, with investors seeing little change in German's supportive policy towards the region's weaker economies after Chancellor Angela Merkel won a third term.

Market reaction was, however, muted as investors were reluctant to put on big positions before preliminary euro zone manufacturing data due at 0758 GMT.

Investors were keen to see the shape of the new government in euro zone paymaster Germany. Merkel won a landslide personal victory on Sunday although her conservatives appeared just short of the votes needed to rule on their own.

Merkel's party may have to convince leftist rivals to join a coalition after their current allies, the Free Democrats (FDP) suffered a humiliating exit from parliament.

"It's somewhat positive for peripheral markets which have done quite well in recent days but we don't expect big moves as this was expected," said KBC strategist Piet Lammens.

"It might start to get things moving again in Europe... Maybe we can get some breakthroughs on the banking union or another aid package for Greece."

Italian 10-year yields were down 0.7 basis points down at 4.29 percent while Spanish equivalents were 1.1 bps lower at 4.32 percent.

Italian yields have fallen since last week on easing tensions after former premier Silvio Berlusconi stepped back from threats to torpedo the government as lawmakers moved closer to banning him from parliament after his tax fraud conviction.

IRISH GAINS

Underpinning the firmer tone in peripheral markets, Moody's on Friday moved closer to upgrading Ireland's credit rating to investment grade by moving its outlook to stable from negative. But it warned the government against easing off on austerity.

It is the last of the three main rating firms to class Irish government debt "junk", rating it Ba1, and the outlook change may fuel expectations of an upgrade before the country exits its 85 billion euro EU/IMF bailout later this year.

Data last week showed Ireland emerged from its second recession in five years in the second quarter. Irish yields were last 2.3 bps lower at 3.87 percent, their lowest in nearly six weeks.

German Bund futures were last 24 ticks up at 138.56 with cash 10-year yields 2.1 bps lower at 1.88 percent.

While many saw little change in German policies towards the euro zone resulting from a coalition between the conservatives and either the Social Democrats or the Greens, some in the market said lengthy talks could unsettle markets.

"A grand coalition may also become unstable in the long run, as the SPD will likely try to avoid the same fate as in 2005-09 when it lost substantial voter support following its participation in a Merkel-led grand coalition government," Citi strategists said in a note.

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