ECB largesse drives yields on lower-rated euro zone bonds lower

Fri Jul 4, 2014 6:21am EDT

* ECB details long-term loan plans; keeps QE on the table
    * Spanish and Italian bond yields fall in "can't-lose" bet
    * Some expect high-yielding Portuguese bonds to outperform

 (Updates prices, adds fresh quotes)
    By Marius Zaharia
    LONDON, July 4 (Reuters) - Yields on lower-rated euro zone
bonds fell on Friday after the European Central Bank fleshed out
the terms of long-term loans it has lined up for banks and said
it stood ready to print money if needed.
    The ECB will give banks the opportunity to borrow up to 1
trillion euros for four years at a rate of only 0.25 percent
from September in the hope they will lend some of that money to
businesses and consumers.
    Peripheral bonds benefit from two aspects of the programme
of targeted long-term refinancing operations (TLTROs).
 
    Firstly banks, which are still deleveraging - most of them 
based in those countries - will get easier terms. Secondly, some
of the cash can be used to buy government bonds, and the only
short-term debt yielding over 0.25 percent is from peripheral
states.
    Spanish 10-year yields fell 3 basis points to
2.67 percent, while Italian 10-year bond yields 
fell 4 bps to 2.72 percent. Both were within touching distance
of record lows hit in June.
    "I don't think the periphery story is over yet," said Marius
Daheim, chief strategist at Bayerische Landesbank.
    "The market has taken some confidence from the ECB's
statements that there will be liquidity around."
    Another factor contributing to the rally was that the ECB
kept the possibility of fighting low inflation with a
large-scale asset purchase programme on the table.
    Irish 10-year yields fell 5 basis points to
2.32 percent, with the bonds extending a rally following
better-than-expected economic data on Thursday. 
    German Bunds, the benchmark for euro zone borrowing costs,
yielded 1.28 percent, 1 bps lower on the day.
    Trading was light because U.S. markets were closed due to
the Independence Day holiday.

    "CAN'T LOSE"     
    Portuguese bonds, which have underperformed
this week due to concerns surrounding an investigation into
holding companies of the country's largest bank, saw their
yields edge up, with 10-year paper at 3.62 percent.
    But some analysts said the ECB's longer-term loans could
help Portuguese bonds outperform in the longer run as their
short-term debt has the highest yield of all.
    Banks who cannot prove they have used the ECB money to lend
to businesses can pay the cash back with no penalty after two
years. That means that lenders can profit if they use the money
to buy relatively high-yielding two-year government bonds.
     At just over 1 percent, two-year Portuguese yields
 are double those of Spanish and Italian bonds.
    "Portugal has the potential to outperform," said Jan von
Gerich, chief fixed income analyst at Nordea.
    "I don't think banks from the core will be going for the
Portuguese bonds. But even if they don't and only the local
banks are buying that would still help."
    Yield differentials are much lower than in late 2011, when
the ECB first offered banks cheap, unlimited three-year money
with no conditions attached. The gains on offer for banks that
invested in three-year Spanish, Italian and Portuguese bonds at
the time ranged from 500 to 1,700 basis points, compared with
15-75 basis points based on current prices.
    But that would not deter some banks from buying bonds with
the cash they borrow, some traders say.
    "At the end of the day what else are you going to do with
your money? It's a safe, can't-lose bet," a trader said.

 (Reporting by Marius Zaharia; editing by Andrew Roche)
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