December 20, 2017 / 12:31 PM / 2 months ago

UPDATE 1-Portuguese bond yields at best level against peers since 2010

* Portuguese 10-year yields now 13 bps below Italy’s

* Lack of political noise compares favourably with peers

* U.S. tax progress pushes other euro zone yields higher

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Writes through)

By Abhinav Ramnarayan

LONDON, Dec 20 (Reuters) - Portugal saw its borrowing costs drop further below Italy’s on Wednesday and the spread over other peers was at its tightest level in years as the country’s impending inclusion into bond indices and stable politics drew in investors.

With political noise surrounding Italy and Spain, the yield on Portugal’s 10-year benchmark bond outperformed the rest of the market, dropping 3.5 bps to 1.77 percent on a day when most other bond yields were unchanged or a touch higher.

At that level, Portugal’s 10-year yield was 14 basis points below the Italian equivalent and just 29.5 bps over Spain.

It was last at those levels in January 2010, and it is a sea change from the start of the year when Portugal was paying a 200-250 basis points premium over its Southern European counterparts to borrow from bond market investors.

The spread over 10-year German Bund yields, the more traditional benchmark security for the euro zone, was 138.5 bps, the tightest since March 2015.

“There is a switch between Italian and Portuguese bonds at the moment because you have this uncertainty over the Italian election in March,” said DZ Bank analyst Rene Albrecht.

“In Portugal on the other hand you have this left of centre government which made some remarkable progress in paying back loans and debt to international investors.”

Euro zone finance ministers have chosen Portugal’s Mario Centeno as the next president of the Eurogroup, a move that Albrecht said was a recognition from the EU of the progress Portugal has made.

Portugal saw its 10-year yields fall below Italy’s for the first time in years earlier this week following a two-notch upgrade from Fitch that could put the country’s debt back into many of the world’s major bond indices.

Italian yields on the other hand have risen sharply in the past week on reports of an upcoming election on March 4, with a hung parliament the most likely outcome.

Though Spain’s government debt has been relatively resilient ahead of a Catalonia vote on Thursday that many hope will resolve Spain’s worst political crisis in decades, it still lags Portugal in recent times.

Debt across the euro zone was hit hard on Tuesday in a sell off triggered by a rise in German borrowing plans for 2016 strong U.S. economic data, and expectations around a U.S. tax overhaul.

On Tuesday night, congressional Republicans hit a last-minute snag in their drive to pass the biggest U.S. tax overhaul in 30 years, requiring them to hold another vote on Wednesday.

U.S. Treasury yields had risen sharply overnight to a two-month high of 2.47 percent, and this pushed high-grade euro zone bond yields higher as the session wore on.

The yield on Germany’s 10-year government debt -- the benchmark for the region -- hit a three-week high of 0.39 percent, up 2 bps on the day.

Most other higher-rated euro zone yields were higher 2-3 bps on the day.

For Reuters 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 Jeremy Gaunt and Elaine Hardcastle

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