LONDON, March 28 Spanish and Italian government bond yields fell to new 8-1/2-year lows on Friday as an unexpected fall in Spanish inflation bolstered expectations that the European Central Bank could ease monetary policy further this year.
Bets on the policy trumped the impact of a looming Italian debt auction in which the Tesoro plans to sell a chunky 10 billion euros of debt. Bond yields usually rise before debt sales as investors make room in their books for the new supply.
The auction is expected to go well as demand for the euro zone's lower-rated debt picked up markedly this week, with speculation growing that the ECB could attempt to fight disinflationary pressures with asset purchases later this year.
Spanish consumer prices were down 0.2 percent year-on-year in March, compared with a previous reading of 0.0 percent and a Reuters poll forecast of a 0.1 percent rise.
That led to expectations that inflation for the whole euro zone, due on Monday, could fall even below the 0.6 percent Reuters consensus. The ECB's target is just below 2.0 percent.
There will be a further pointer on euro zone inflation from German inflation data, due at 1300 GMT. Expectations are for a 1.0 percent rise.
Italian 10-year bond yields stood 3 basis points lower on the day at 3.275 percent, having earlier hit their lowest level in 8-1/2 years at 3.266 percent, according to Reuters data. That compares with levels of 3.29 percent before the Spanish inflation figures.
SPANISH YIELDS ALSO DOWN
Spanish 10-year yields also hit new eight-year lows of 3.216 percent. Any ECB easing would at least anchor yields on top-rated bonds at ultra-low levels, prompting investors to look down the ratings scale to maximise returns.
"This is an ECB expectations-driven story," said Ralf Umlauf, an analyst at Helaba Landesbank Hessen-Thueringen. "The market is definitely positioning for next week's meeting. Market players are expecting some action - any kind of action."
German 10-year Bund yields, the benchmark for euro zone borrowing costs, fell 1.5 bps to 1.517 percent.
Italy is offering fixed-rate 2019 and 2024 bonds and 2019 floating rate bonds linked to six-month Euribor at an auction, whose results will be published after 1000 GMT.
One trader said "Demand is there", even if yields had not picked up before the auction as they usually do.
The recent increase in demand for Italian bonds has come from both international investors and domestic buyers, traders said. ECB data showed local banks added 6.5 billion euros of Italian bonds in February.
"With 10-year yields falling to the lowest level since 2005 and fresh ECB data suggesting ongoing domestic support, the auction should be easily digested," Commerzbank strategists said in a note. "We thus stick to our bullish stance on peripherals, with 10-year BTPs (Italian bonds) in particular offering value." (Reporting by Marius Zaharia; Editing by Kevin Liffey)