July 5, 2016 / 4:30 PM / 3 years ago

UPDATE 2-Italy's bond yields rise as government counts cost of bank problems

(Adds German and UK record low yields, quotes, updates prices)

By John Geddie

LONDON, July 5 (Reuters) - Italian government borrowing costs rose on Tuesday on signs that Rome will need to use public money to avert a new crisis in its banking sector, while worries about the growth outlook drove yields on low-risk debt to record lows.

Rising Italian yields hauled equivalents in Southern Europe higher but concern about global economic health after Britain’s vote to leave the European Union and prospects of looser monetary policy drove German 10-year yields down 5 basis points on the day to an unprecedented minus 0.18 percent.

Ten-year U.S. and UK yields also hit record lows, as did yields on 20-year Japanese government bonds while Swiss 50-yields fell below zero for the first time.

“However the Brexit issue unfolds, it is likely to be supportive of safe haven assets both as it is likely to weigh on confidence and thereby dampen any incipient inflationary pressure and as it tilts the odds to more policy stimulus,” said Richard McGuire, senior fixed income strategist at Rabobank.

The ECB on Monday opened the door to state aid for euro zone banks as Italy negotiates a plan to recapitalise lenders and allow them to work through a mountain of bad debt.

Italy’s third-largest lender Banca Monte dei Paschi di Siena has been at the centre of concerns after the ECB on Monday asked the bank to slash its bad debts by 40 percent over three years, while stress tests at the end of this month could unveil wider issues in the sector.

A bank bailout fund set up using mainly private cash, is increasingly seen as insufficient to tackle the problem.

“People are now looking at the government to step in and that is the channel by which government bonds are being affected,” ING strategist Martin van Vliet said.

Italy’s 10-year government bond yield rose 3 basis points to 1.19 percent at one point before pulling back to 1.18 percent, still up 1.7 basis points on the day.

On Friday, it hit one-year lows, as the economic shockwaves from Britain’s vote to leave the EU raised expectations for more central bank easing in Europe.

Shares in Monte dei Paschi fell nearly 20 percent, making it the biggest faller on the STOXX 600 index. The Italian banking index fell 1.8 percent after a 4 percent slide on Monday and has shed 56 percent so far this year.

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

In a research note titled ‘new banking crisis in Italy?’, DZ Bank’s Birgit Figge said concerns around Monte dei Paschi’s bad loans had prompted investors to take profits on peripheral bonds that had appreciated sharply last week on ECB easing bets.

Spanish and Portuguese equivalents also rose 2-3 bps to 1.19 percent and 3.01 percent respectively.

German 10-year yields, the euro zone benchmark, fell to minus 0.18 percent, surpassing the minus 0.169 trough hit just after the June 23 Brexit vote.

U.S. 10-year Treasury yields fell as far as 1.368 percent and UK 10-year gilt yields as far as 0.774 percent.

“With central banks, particularly the Bank of Japan, the European Central Bank and possibly the Bank of England in coming months buying sovereign bonds, this demand/supply imbalance is set to persist,” said Nick Stamenkovic, bond strategist at RIA Capital Markets. (Additional reporting by Nigel Stephenson and Dhara Ranasinghe, Editing by Janet Lawrence)

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