Portugal's clean exit, ECB bets drive periphery yields at record lows

Tue May 6, 2014 12:45pm EDT

Related Topics

* Markets welcome Portuguese plans for "clean" bailout exit

* Portuguese bond yields at 8-year lows

* Italian 10-year yields fall below 3 pct

* Some expect ECB to stop sterilising bond purchases (Adds Fitch, fresh analyst comments, updates prices)

By Marius Zaharia

LONDON, May 6 (Reuters) - Yields on some of the euro zone's lower-rated bonds hit record lows on Tuesday as investors welcomed Portugal's plans for a "clean" exit from its bailout and kept faith in some future easing of ECB monetary policy.

Following in the footsteps of Ireland, Portugal said it would end its international bailout this month without a back-up loan. Barely two years ago, investors saw Lisbon as at risk of defaulting on its debts.

Now, far from worrying about the lack of a future safety net, market participants see Portugal's move as confirmation the euro zone debt crisis is subsiding.

Portuguese 10-year yields were last 4 basis points lower on the day at 3.60 percent. They had hit an eight-year low of 3.568 percent earlier, according to Reuters data - compared with more than 17 percent at the height of the crisis in 2011-2012. Few would have predicted then that a country whose debt stands at 1.3 times its economic output and unemployment at around 15 percent could regain investor confidence so swiftly.

"Despite these challenges ... we believe Portugal's bailout exit represents an important symbolic transition from the worst of the crisis," said Dennis Shen, economic associate at AllianceBernstein.

Yields in the euro zone's other weaker states were also 2-3 basis points lower. Ten-year yields in Spain, Italy and Ireland reached record lows at 2.93 percent, 2.988 percent and 2.739 percent, respectively.

Reflecting this turnaround in sentiment for countries which two years ago were at the forefront of the euro zone debt crisis, rating agency Fitch said on Tuesday there was potential for credit rating upgrades for these countries in a scenario of ecnoomic recovery and declining debt ratios.

Ireland, Portugal and Spain had the greatest medium-term potential, in a favourable scenario, for multi-notch rating recoveries because their creditworthiness fell further during the crisis, it said in a statement.

ECB OUTLOOK

The trend of falling yields was supported by expectations the European Central Bank may ease monetary policy further, as inflation remains below expectations and more than a percentage point below target.

No rate cut is seen at the ECB's meeting on Thursday, and any move to print money by buying assets is likely to be some way off. However, recent stress in money markets has rekindled some expectations of another liquidity injection.

That could come from suspending weekly ECB deposit tenders. Those are aimed at draining from the market an amount equal to the outstanding volume of government bonds the central bank bought through its Security Market Programme (SMP) at the height of the crisis.

These "sterilisation" operations were introduced to quell any concerns that the SMP was directly financing state budgets, something the ECB is not allowed to do. Suspending sterilisation would release 167.5 billion euros into the market.

Speculation that the ECB might consider such a move picked up at the end of last month when overnight bank-to-bank Eonia lending rates spiked above the 0.25 percent refinancing rate. Consequently, the ECB failed to drain the full intended amount.

Last month's failure, coupled with an increased take-up from banks at the ECB's weekly offerings of unlimited loans, was the equivalent of a liquidity injection, which eased tensions in the money market. Eonia rates have fallen back to 0.126 percent.

"For now it's still at a level where it's going to force the ECB's hand. If you combine that with the fact that downside risks to inflation are still there but have eased slightly, we expect more promises of potential action from the ECB on Thursday," said ICAP strategist Philip Tyson.

He and others in the market say given the tick up in euro zone inflation last month, policymakers were likely to wait until the May figure and for their own growth and inflation forecasts in June before acting. (Additional reporting by Emelia Sithole-Matarise, Editing by Larry King/Ruth Pitchford)

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