(Corrects date of Portugal's draft budget in paragraph 2)
* Portugal cuts deficit target for 2017
* German paper reports possible establishment of Portugal
* Spanish and Italian yields also dip
By Abhinav Ramnarayan
LONDON, Oct 18 Portugal's government bond yields
hit one-month lows on Tuesday ahead of a crucial ratings review
from DBRS this week.
Portugal on Friday slashed its deficit target for 2017 to
1.6 percent of economic output from this year's estimated 2.4
percent, and a report overnight from German
newspaper Handelsblatt suggested the government is planning to
set up a bad bank to deal with the struggling banking sector.
Those two developments strengthened expectations that DBRS
would leave the country's last investment grade rating untouched
at a scheduled review this Friday.
Concerns over the rating - with eligibility for the European
Central Bank's asset purchase programme in the balance - has
weighed on Portugal's government bonds since
"I think the market now believes the investment grade rating
should survive, and we tend to that view as well," said
Commerzbank rates strategist David Schnautz. "It remains to be
seen if this is just a feel good environment or if it is
He sounded a note of caution, saying that it remains to be
seen if the deficit target - part of the draft budget proposal
for 2017 - proves feasible.
Portugal's 10-year bond yields rose from an Aug. 15 low of
2.69 percent all the way up to 3.63 percent last Monday, October
10. Since then, government comments suggesting the rating was
safe and further good news have pushed yields lower.
On Tuesday, the yield on the Portugal 10-year benchmark
fell 1.5 basis points to 3.25 percent by 0700 GMT,
before rising again.
One of DRBS's key concerns have been around the Portuguese
banking sector, and the government is planning to create a bad
banks to absorb its bank's non-performing loans (NPLs),
Handelsblatt reported on Monday.
"This is a reminder that there are issues for Portugal
beyond Friday's review, and NPLs are a very difficult beast to
tackle," said Schnautz. "Though the mechanics of the bad bank
are still unclear, at the very least they are dealing with issue
The yield on other southern European government bonds also
fell on Tuesday, with Spain's 10-year bond yields dropping 1.3
bps to 1.11 percent and Italy's 10-year dropping 1.2 bps to 1.39
Higher-rated euro zone government bonds were more or less
flat on the day, following Monday's sharply volatile session.
For Reuters new Live Markets blog on European and UK stock
markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets
(Reporting by Abhinav Ramnarayan; Editing by Alison Williams)