Irish bond rally nears new milestone, rating boost eyed

Mon May 12, 2014 12:36pm EDT

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By John Geddie and Emelia Sithole-Matarise

LONDON, May 12 (Reuters) - Irish bond yields held near record lows on Monday, a whisker above equivalent U.S. borrowing costs, and were poised for further impetus from an expected ratings upgrade from Moody's this week.

Having dropped below UK Gilt yields on Friday for the first time in six years, the country's 10-year bonds could shortly set another milestone and slip below global benchmark U.S. yields, supported by Ireland's economic recovery coupled with accommodative central bank policy.

The divergence in policies, whereby the European Central Bank has raised the prospect of asset purchases if inflation remains ultra-low, while the U.S. Federal Reserve is scaling back its own programme, is spurring investor appetite for peripheral euro zone bonds.

"At some point, European and U.S. rates will sharply decouple, and we would expect Irish bonds to trade well through U.S. Treasuries," said Marco Brancolini, a rates analyst at RBS. The bank is predicting a one-notch upgrade for Ireland when Moody's releases its latest credit review of the country on Friday.

Irish 10-year yields outperformed other peripheral bonds on Monday, dipping 2 basis points in early trade to hit 2.66 percent before retracing to last trade at 2.67 percent. UK and U.S. yields were quoted at 2.73 percent and 2.65 percent, respectively.

Ratings upgrades in the periphery continued on Friday, when Standard & Poor's lifted Portugal's credit outlook to stable from negative, and Moody's upgraded it by one notch.

ECB EXPECTATIONS

This provided fresh momentum to a peripheral rally that had seen Italian, Spanish and Irish yields hit record lows, and few expect a major reversal of these gains with the ECB ready to deliver fresh monetary stimulus next month.

"Obviously the whole story driving the market is the very large expectation that the ECB will deliver. There's a risk they may not deliver in June," said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers.

Others expect yields to fall even further, especially for Portugal which still offers relatively higher yields and as some in the market expect the country to regain investment grade credit status in coming months.

"We are long Portugal and have been for some time even though it is sub-investment grade because in this policy mix we are likely to see upgrades take Portugal back to investment grade," said Jack Kelly, investment director for fixed income at Standard Life.

Traders said an escalation in unrest in Ukraine, after anti-Kiev rebels declared victory in a referendum on self-rule, was taking the gloss off last week's rally, leading to some minor profit-taking elsewhere in the periphery.

Spanish and Italian yields rose 4 bps and 2 bps respectively, to hit 2.94 percent and 2.97 percent. Greek and Portuguese equivalents rose 10 bps and 5 bps to 6.21 percent and 3.59 percent, respectively.

It was an unremarkable backdrop for Spain to begin marketing its first ever bond linked to euro zone inflation.

Pension and insurance companies that need to hedge their liabilities against inflation have proved resilient buyers of linkers in recent years despite muted prospects for consumer price growth. However, with euro zone inflation now running at just 0.7 percent, well below the ECB's target of just under 2 percent, extra demand for Spain's inaugural issue is likely to be capped. (Editing by Susan Fenton)

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