Lower-rated euro zone debt yields at new lows on ECB

Fri May 9, 2014 3:50am EDT

* Euro zone bonds buoyant after ECB signals could ease policy in June

* Spanish, Italian, Irish yields at new record lows

* Portuguese yields lower after S&P revises credit outlook

* Money market rates fall sharply

By Emelia Sithole-Matarise

LONDON, May 9 (Reuters) - Lower-rated euro zone bond yields fell to new lows on Friday after the European Central Bank bolstered expectations it was poised to deliver fresh monetary stimulus next month.

A Standard & Poor's upgrade of Portugal's credit outlook to stable from negative added to the positive sentiment and gave a further boost to Lisbon as it prepares to exit its internatinal bailout this month. Moody's is expected to at least follow suit after the market close.

The focus remained on the ECB after President Mario Draghi gave his clearest signal yet on Thursday that policymakers might act in June to stem slowing inflation. Money market rates have tumbled, with the one-year, one-year Eonia rate - the most traded contract in the forward market - dropping to its lowest in a year on Friday as traders firmed up easing bets.

This gave fresh impetus to the rally in lower-rated bonds, which has been relentless this year after the ECB raised the prospect that it could embark on an asset purchase programme, or quantitative easing, if inflation remained persistently low.

Yields on Italian, Spanish and Irish 10-year bonds hit record lows on of 2.91 percent, 2.87 percent and 2.68 percent respectively, outperforming benchmark German Bunds which were held steady.

"The market is trading the ECB options, both of a rate cut in June and maybe further ahead of quantitative easing. That's why we are seeing the outperformance in non-core paper," said Alessandro Tentori, global head of rates strategy at Citi.

"If the scenario is that rates are going to stay low for a very long time and not just the next two years, and if you are going to have QE, there's no reason to price any spread at all."

Tentori added that the ECB's strong easing signal could also prompt some investors, especially in Asia, who were still wary of the euro zone's lower-rated bonds, to buy into the market and lock into the relatively higher returns they offer.

CAUTION

Portuguese 10-year yields fell 2 basis points to 3.45 percent, the lowest since early 2006, after S&P lifted the country's credit outlook early on Friday, far from peaks above 17 percent hit at the height of the euro zone debt crisis.

The move was largely expected by analysts and marks a big turnaround in sentiment for a country which was seen at risk of defaulting on its debt just two years ago.

Some market participants are becoming cautious after the rapid fall in yields.

"In the European periphery we remain invested in Portuguese and Slovenian government bonds," said Scott Thiel, head of European Global Bonds at Blackrock.

"However, given their significant spread compression to German Bund yields in recent weeks and in light of excessive market expectations for imminent quantitative easing in the euro zone, we have reduced these positions."

(Editing by Catherine Evans)

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