Italy, Spain bonds rise after ratings boost, election fears remain

Fri May 23, 2014 7:58am EDT

* Low-rated bonds inch up after ratings upgrades

* Slowing German growth ups pressure on ECB support

* Election fears centre on Greece, Italy

* Moody's verdict on France, Slovenia awaits (Updates prices adds new comments)

By John Geddie

LONDON, May 23 (Reuters) - Peripheral euro zone bonds were mostly higher on Friday after a ratings hike for Spain, and as expectations of imminent European Central Bank policy easing allayed niggling concerns about the outcome of EU elections.

Unease about a potentially destabilising strong showing by eurosceptic parties in European elections that conclude on Sunday have weighed on markets this week, but they have been offset by expectations of ECB intervention to nurture's the euro zone's fragile recovery.

"The recent sell-off will have injected a note of caution, but I think the consensus is that you should favour peripheral bonds over core bonds in this low-yield environment," said Sandra Holdsworth, investment manager at Kames Capital.

Yields on Italian bonds - which are the most liquid of all peripheral government cash markets - dropped by 6 basis points in the 10-year maturity to 3.18 percent, easing back off two-month highs hit Wednesday.

After a widely-expected rating upgrade from Standard and Poor's, Spanish equivalents rallied by the same amount to 3.00 percent.

Portuguese yields dipped to 3.80 percent following news that the country's public sector deficit in the first four months of the year fell below forecast.

S&P brought its rating for Spain in line with Moody's, lifting it to BBB from BBB- based on its economic prospects. Fitch remains the most optimistic on Spain, with its rating of BBB+ one notch above the other two main agencies.

Moody's was scheduled to deliver its verdict on France and Slovenia later on Friday, with the former widely rumoured for a downgrade and the latter tipped for an upgrade.

RISKS REMAIN

But Greek 10-year yields lagged other peripheral bonds rising 2 bps to 6.56 percent despite a rating hike by Fitch to B from B- with a stable outlook.

With the upgrade, Fitch becomes the most bullish agency on the country which defaulted just two years ago, although its rating is still five notches below investment grade.

A strong showing by Greece's anti-bailout parties in the European elections may hurt an already-fragile coalition, potentially paving the way for national elections.

Political risks also remain in Italy where a poor result for Prime Minister Matteo Renzi's party might weaken his drive for the swift reforms he promised when he took power.

Strategists earlier on Friday called for caution ahead of the election results, most of which are due on Sunday, and what is a long weekend for U.S. and UK markets, recommending investors favour safe-haven bonds.

"The short-term outlook ahead of the weekend still looks shaky...(German) Bunds look supported," said Commerzbank in a research note.

However, 10-year Bunds struggled, rising 1 basis point to 1.37 percent. Economists and the government in Berlin predict German growth will slow after a strong first quarter, while its leading indicator of business morale fell to its lowest level since the start of the year in May.

The ECB has already signaled possible monetary easing actions at its June policy meeting next week. Weak economic data revives the debate over whether it will start printing money to fight deflation and boost growth, said bond traders.

"There is still faith in the ECB and a lot of expectation that (ECB President Mario) Draghi will be able to announce some additional stimulus measures in June," said Chris Iggo, CIO Fixed Income, AXA Investment Managers. (Editing by Toby Chopra and John Stonestreet)

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