June 4, 2018 / 7:52 AM / in 10 months

Southern Europe's bond yields fall as calm returns

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, June 4 (Reuters) - Italy’s bond market continued its recovery on Monday as investors took comfort for now from the creation of a government in Rome that ends months of political turmoil, while the risk of more U.S. rates hikes added to a selloff in German debt.

Short and long-dated Italian bond yields, which soared last week on fears that the possibility of a new election might have effectively become a referendum on euro membership, fell more than 15 basis points in early trade.

While the two anti-establishment parties that make up Italy’s government are set on big spending plans that are likely to put upward pressure on borrowing cost longer-term, stability in Rome has bought some calm to markets for now.

In a reassuring sign for investors, Italy’s new Economy Minister Giovanni Tria said late on Friday that none of the country’s parties wanted to leave the euro zone and neither did he.

“We have more clarity and now it’s up to investors to assess the risk outlook,” said Commerzbank rates strategist Rainer Guntermann. “There is a bit more relief.”

Italy’s 2-year bond yield was down 23 basis points at 0.79 percent, having briefly surged last week to 5-year highs around 2.7 percent.

Italian 10-year bond yields were down 17 bps at 2.56 percent , squeezing the gap over top-rated German bond yields to 215 bps from around 226 bps late Friday.

Analysts said comments from German Chancellor Angela Merkel at the weekend helped support sentiment towards peripheral bond markets.

Merkel has ruled out debt relief for Italy, saying in a newspaper interview published on Sunday that the principle of solidarity among euro zone member states should not turn the single currency bloc into a debt-sharing union.

But she also has offered her most detailed response to French President Emmanuel Macron’s ideas for reforming Europe, seeking to avert a damaging rift with Paris at a time of high anxiety over Italy and growing transatlantic tensions.

Portugal’s 10-year bond yield fell to a two-week low at 1.78 percent, while Spanish bond yields were down 8 bps at 1.38 percent.

On Friday, Spanish socialist Pedro Sanchez took over as prime minister from veteran conservative Mariano Rajoy, who lost a no-confidence vote in the wake of a corruption scandal.

Slovenian bond yields rose after news that a right-wing opposition party won the most votes in a parliamentary election on Sunday, but not enough to form a government on its own.

Still, the recovery in southern European bond markets continued to dent the appeal of safe-haven bonds.

Germany’s 10-year bond yield rose 2.5 bps at 0.40 percent , also facing upward pressure from higher U.S. Treasury yields.

U.S. Treasury yields rose on Friday after data showed the world’s largest economy created more jobs than expected in May, fuelling expectations that the Federal Reserve could increase the pace of interest rate rises this year.

Reporting by Dhara Ranasinghe; Editing by Toby Chopra

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