Lower-rated euro zone bond yields dip as Ukraine crisis eyed

LONDON, July 21 Mon Jul 21, 2014 4:13am EDT

LONDON, July 21 (Reuters) - Yields on lower-rated euro zone bonds slipped on Monday as riskier assets tentatively recovered on hopes the coming days might bring a diplomatic solution to the Ukraine crisis after the downing of an airliner over the country last week.

The fact the situation did not deteriorate over the weekend stabilised markets, though the lack of concrete developments kept price moves modest and benchmark German yields pinned near record lows.

The plane crash on Thursday, blamed by Western countries on pro-Russian rebels in Ukraine, prompted a sell-off in riskier assets such as equities and drove investors into the perceived safety of top-rated government bonds.

The incident intensified tensions between the West and Russia, which initially flared after Russia annexed Ukraine's Crimea region and expressed support for separatist rebels in the east of the country.

Some in the market reckon the loss of the Malaysian jet will trigger a diplomatic solution to the worst crisis between Russia and the West since the Cold War.

"Investors don't seem as worried as they were last Friday," said Christian Lenk, a strategist at DZ Bank. "There are simply some hopes now implicitly that maybe we have seen a culmination of that conflict and may see some easing in the near future."

Italian 10-year yields were 2 basis points down at 2.79 percent while Spanish equivalents were 1.5 bps lower at 2.61 percent.

SPAIN PLANNING 50-YEAR BOND?

Traders were keeping an eye on a potential debt sale from Spain, after a newspaper report said Madrid could sell a 50-year bond via private placement.

Spanish financial daily Expansion quoted Inigo Fernandez de Mesa, the head of treasury, as saying that he could not rule out a 50-year private placement since demand for ultra-long term paper among international investors has grown.

Spain and Italy have met more than 70 percent of their funding needs for this year, taking advantage of record low borrowing to frontload bond sales and extend the maturity of their debt.

Hefty redemptions and coupon payments later in the month and about 1 trillion euros in cheap loans to banks from the European Central Bank due from September were also supporting demand for peripheral euro zone bonds, which still offer a relatively higher yield pick-up over core bonds.

German 10-year yields, the benchmark for euro zone borrowing costs, were a touch lower at 1.15 percent, within sight of an all-time low of 1.126 percent hit at the height of the debt crisis in mid-2012.

"In the absence of more bad news, core yields could creep a bit higher today, but in general the upside still looks limited in the near term, as risks remain the geopolitical tensions will only increase and the cash flow picture remains rather supportive," Nordea strategists said in a note. (editing by John Stonestreet)

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