* Italy, Spanish yields head towards record lows
* Bunds also rally on Fed stance
* Eonia rate fixes at record low due to ECB measures
(Updates prices, adds fresh quote)
By Emelia Sithole-Matarise
LONDON, June 19 Peripheral euro zone bond yields
headed back towards historic lows on Thursday in a market-wide
rally after the U.S. Federal Reserve signalled that rising
inflation would not trigger an increase in rates any time soon.
Longer-dated euro zone bonds sold off earlier this week
after higher-than-expected U.S. consumer price inflation raised
the possibility that the Fed might be open to lifting interest
rates sooner than many in the market had previously thought.
But the Fed did not note any inflation concerns after its
policy meeting on Wednesday at which policymakers lowered their
long-term rate target and affirmed a commitment to retaining
accommodative monetary policy.
This accelerated the hunt for yield in euro zone bonds which
were already buoyant from the European Central Bank's interest
rate cuts and liquidity measures taken two weeks ago.
Italian and Spanish 10-year yields fell 5 basis points to
2.80 percent and 2.71 percent
respectively, within sight of record lows hit last week, while
Greek equivalents dropped 6 bps to 5.89 percent.
Yields on top-rated euro zone bonds were 5-7 bps lower.
"In the current climate, the market feels central banks
won't rush into anything silly," said Alan McQuaid, chief
economist at Merrion Stockbrokers.
German bonds, the euro zone benchmark, unwound some of their
outperformance relative to U.S. Treasuries, but the spread was
still around its widest in seven years, reflecting the different
policy outlook of the Fed and the ECB.
The Fed is trimming its monetary stimulus and is expected
to start raising rates next year, while the ECB is set to
maintain an ultra-easy policy for longer.
BNP Paribas strategist Patrick Jacq said he expected Bunds
to resume their outperformance of Treasuries, predicting the
U.S. 10-year T-note yield premium would gain a further 10 bps in
coming weeks to more than 130 bps, taking it back to 1999 peaks.
The ECB's June 5 decision to cut interest rates and inject
liquidity into the market has also driven short-term money
market rates to historic lows, with the overnight bank-to-bank
Eonia rate tumbling close to zero.
Eonia fixed at 0.015 percent on Wednesday, the
latest in a series of record lows after the ECB stopped a weekly
deposit tender to neutralise the effect of the bond purchases it
made at the height of the debt crisis, injecting tens of
billions of euros into the market.
The central bank's measures have given extra impetus to the
two-year-long investor hunt for yield in the euro zone's weaker
economies that has squeezed some borrowing costs to record lows.
This enabled Cyprus to return to markets on Wednesday a
little more than a year after it was bailed out.
Greece also returned to market with an issue of five-year
bonds in April. Athens plans another bond sale in coming months.
Investors' willingness to take higher risks to maximise
profits is, however, exacerbating fears that some bonds have
become overvalued and that some of the euro zone's struggling
economies may ease off on fiscal reforms.
While he saw potential for peripheral euro zone yield
premiums over German benchmarks to fall further, Amundi Asset
Management's Philippe Ithurbide said it was "increasingly urgent
to stick to what is liquid and demonstrably solvent".
"Not because we expect a resurgence in the banking or
sovereign debt crisis, but simply because questions on excessive
valuations will be increasingly legitimate," he said in a note.
Vanguard Group Inc's new bond chief, Gregory Davis, said at
a Reuters summit on Wednesday that investors could be ignoring
warning signs in less stable countries in their search for
yield. His unease was echoed by Deutsche Bank
co-chief Anshu Jain who said he was worried the ECB's recent
policy measures could remove the incentive for reform.
"You look at it (the rally) and you think it's crazy," said
McQuaid at Merrion.
(Additional reporting by Marius Zaharia; Editing by Nigel
Stephenson and Keiron Henderson)