* German Bunds rally to highest since September 2010
* Two-year bond yields tumbled on liquidity prospects
* Italian/German 10-year yield spread at euro era highs
By Ana Nicolaci da Costa
LONDON, Aug 4 The Italian government bond yield
premium over Bunds rose to euro era peaks on Thursday on signs
the European Central Bank had no immediate plans of buying
Italian and Spanish bonds to arrest a worsening sovereign debt
The ECB said after leaving interest rates unchanged at 1.5
percent that it would broaden its liquidity operations as it
revived its bond buying programme in the secondary market by
purchasing Portuguse and Irish bonds.
A euro zone monetary source said ECB bond purchases in the
secondary market would be confined to those countries, fueling
worries that the debt crisis would sweep Italy and Spain into
"The SMP is back but it's not in the right places, what's
going to stop us attacking Spain and Italy over the summer
months, cause I can't think of anything," said a trader in
"There is no buying of Italy and Spain going on and there
won't be, so why can't we push these markets to 7 percent
yields, I think we can quite easily," the trader said.
The 10-year Italian/German bond yield spread
widened to 392 basis points, the most since the launch of the
euro in 1999 while the equivalent Spanish spread expanded to 400
bps from 386 bps at Wednesday's settlement.
German Bund futures FGBLc1 jumped to their highest level
in nearly a year while the prospect of more liquidity in the
euro system took two-year German bond yields to their lowest
since January, steepening the two-/10-year yield curve.
THE MAGIC NUMBER
Italian and Spanish 10-year bond yields rose firmly above 6
percent and investors feared that a key 7 percent level was now
easily within reach.
That level is considered a point of no return, above which
funding costs become unsustainable and a country can quickly
struggle to raise funds in commercial markets.
Portugal, Greece and Ireland -- whose yields are currently
at double digits -- had to seek financial rescue and are mostly
dependent on the ECB for their funding.
Ten-year Portuguese and Irish bond prices were up sharply
with yields more than 20 basis points lower on the day.
"The alarm bells (are) ringing in the ECB tower," Kornelius
Purps, fixed income strategist at UniCredit said.
"Now the ECB is not only going to expand or extend the
existing measures, the ECB is coming up with an emergency
funding line for 6-months which is definitely a signal that the
ECB sees pressure out there."
The two-year German government bond yield fell
as far as 0.84 percent -- far below current euro zone interest
Money markets were beginning to price in a possibility of a
rate cut early next year, even though the ECB hiked interest
rates in July. Increased liquidity made it hard to make out an
accurate picture of interest rate expectations.
The German Bund future settled at 132.79, up 98 ticks on the
day after hitting a high of 133.17.