* Ireland/Germany 10-year spread hits widest since June 5
* Sterling hits 28-month low on no-deal Brexit worries
* German inflation expected to undershoot ECB target
By Abhinav Ramnarayan
LONDON, July 30 (Reuters) - Irish government bond yield spreads over Germany hit their widest in nearly two months on Tuesday, as chances rise of a no-deal Brexit that would cause particular damage to Ireland.
Sterling has dropped to 28-month lows against the dollar and euro on growing worries that Britain will leave the European Union without a deal on Oct. 31 under new Prime Minister Boris Johnson. British government bond yields fell to their lowest since mid-2016.
In the euro zone bond market, Ireland has been hardest hit; Britain is Ireland’s biggest trading partner, and the border between Northern Ireland and the Republic of Ireland is a key issue in negotiations.
“In light of the new cabinet’s comments, we have replaced the Irish government bonds held within our sovereign benchmarked funds, replacing this risk with Spain as Irish bonds continue to price in very little hard Brexit risks,” said UBP’s Mohammed Kazmi, who is portfolio manager of the UBAM Absolute Return Low Vol Fixed Income Fund.
The Ireland/Germany 10-year bond yield spread widened to 59 basis points at one point, the widest since June 5, before easing to 56 bps towards the close of the session.
The Irish 10-year yield rose as high as 0.207%, the highest since mid-July and the Dublin stock market fell 2.2% for its worst day since October
“The upward shift (in Irish spreads) is due to the change in tone in Westminster and that the tail risk of a no-deal Brexit is being priced in,” said DZ Bank rates strategist Daniel Lenz.
“We know that trade links between Ireland and the UK are very strong, and trade would be very much affected and there would also be political concerns related to the border. It is still only a tail risk but the tail is growing,” he added.
The widening in Irish spreads contrasts with similarly-rated France and Belgium, both of which have seen their spreads with Germany tighten in recent weeks.
Other euro zone government bond yields held just off recent lows. They were not impacted significantly from a rise in U.S. Treasury yields that followed data showing consumer confidence rebounding to the highest since November.
Germany’s 10-year government bond yields were hovering near the ECB’s minus 0.40% deposit rate mark on Tuesday morning ahead of a Federal Reserve meeting in which policymakers are expected to lower rates and potentially signal more cuts.
Deepening concerns over a no-deal Brexit and disappointing French economic growth data is also keeping alive the bid for safe-haven assets.
Germany’s July inflation fell to the lowest since November 2016, data showed, lending support to the European Central Bank’s dovish impulse. Data showed prices rose 1.1% year-on-year after increasing 1.5% in June, undershooting Reuters forecasts for 1.3% and off the ECB’s near 2% target for the euro zone.
French growth slowed unexpectedly in the second quarter while German consumer morale worsened for the third month in a row heading into August, adding to signs that the euro zone economy as a whole is cooling.
A long-term market gauge of euro area inflation has dipped back to 1.33%, having risen to 1.358% after the ECB’s easing pledge last week.
French 10-year bond yields remained deeply in negative yielding territory at minus 0.144%.
Reporting by Abhinav Ramnarayan, Additional reporting by Andy Bruce; editing by Sujata Rao and John Stonestreet