Italy, Spain yields dip after ratings boost, election fears remain

Fri May 23, 2014 11:10am EDT

* Peripheral yields drop after Spain rating upgrade

* ECB easing expectations also provide support

* Election fears centre on Greece, Italy

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

By John Geddie

LONDON, May 23 (Reuters) - Yields on higher-risk euro zone bonds mostly fell 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 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 8 basis points in the 10-year maturity to 3.16 percent, easing back off two-month highs hit Wednesday.

After a widely-expected rating upgrade from Standard and Poor's, Spanish yields fell 6 bps to 2.99 percent.

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.

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.

Italian, Spanish and Irish yields have come a long way this year, prompting some fund managers to book profits.

BlackRock, the world's biggest asset manager, said on Friday one of its main bond funds had cut its holdings of peripheral euro zone government debt to their lowest since the height of the crisis.

RISKS REMAIN

But Greek 10-year yields lagged other peripheral bonds rising 1 bps to 6.55 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 two years ago. The 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.

Some in the market think, however, that a strong showing of anti-establishment parties could prompt the mainstream ones to put their differences aside.

"The rise in support at the fringes could, unintentionally, make the European Parliament even more ... pro-integration," said Dennis Shen, economics associate at AllianceBernstein. (Additional reporting by Marius Zaharia; Editing by John Stonestreet/Ruth Pitchford)

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