April 12, 2012 / 3:55 PM / 7 years ago

EURO GOVT-Italian bonds rally after clearing auction hurdle

* Italy yields fall across curve, investors edge into market

* Spanish debt continues to lag, remains focus of concerns

* Return of ECB bond-buying scheme eyed, analysts sceptical

By William James and Marius Zaharia

LONDON, April 12 (Reuters) - Italian debt rallied for a second day running on Thursday after clearing its latest round of bond auctions, but investors were likely to remain cautious towards peripheral euro zone countries for the foreseeable future.

Italy’s 4.88 billion euro sale produced mixed results, but some had anticipated a weaker auction. A better than expected showing prompted buyers to cautiously re-enter the market and drove yields lower across the curve.

“We were slightly disappointed with the three-year auction results but obviously the other issues were very solid indeed,” a trader said.

“Having got very close to that 4 percent level at the (three-year) auction, that immediately got buyers coming in and it’s been one-way traffic since then.”

Ten-year Italian yields fell by 13 basis points to trade at 5.40, while the three-year benchmark tapped at auction rallied 12 bps to 3.84 percent.

Appetite for higher-yielding debt cooled demand for low-risk Bund futures which fell 25 ticks to 139.67.

The Italian rally helped make up for some of the ground lost by Italian debt in the last month due to a move away from lower-rated euro zone bonds fuelled by concerns over Spain’s ability to control its public finances and generate economic growth.

Spanish bond yields also fell, down 6 bps to 5.81 percent. However, the relatively small change reflected underlying pessimism towards debt issued by Spain compared to the more positive view of Italy, which is perceived to have made better progress on reform under Prime Minister Mario Monti.

“The credit that Italy has earned so far may still be working so (short-term) we should probably see some more outperformance of Italy versus Spain. I’m not so sure going beyond that, I’m kind of pessimistic,” said Alessandro Mercuri, a strategist at Lloyds Bank in London.

For Spain, the near-term focus is on the psychologically key 6 percent level that, if broken, might raise concerns a door had been opened to 7 percent - a level beyond which debt servicing costs are widely deemed unsustainable.

Peter Allwright, head of absolute return on rates and currency at RWC Partners, which manages assets worth about $4 billion, said markets were slowly heading back towards the stress levels seen in November 2011, before the European Central Bank offered banks massive amounts of cheap three-year cash.

“It’s very hard to justify a long (stance on) Spain. We look at housing, ... the regional deficits, the private debt, the banking debt,” Allwright said. “While stuck in an uncompetitive currency regime it is very difficult for them.

“There is a lot of hope that the ECB may come in (and buy Spanish bonds)... but we may get to 6.5 percent and 7 percent before they do.”

BOND BUYS BACK ON AGENDA?

Talk the European Central Bank may re-activate its bond-buying programme also helped underpin peripheral bond prices.

The ECB’s stalled bond purchase scheme edged back into focus after executive board member Benoit Coeure said on Wednesday it remained an option, adding that the scale of market pressure on Spain was not justified given its reform plans.

But analysts said the mechanism might have lost some of its credibility and questioned its ability to curb any further bouts of peripheral pressure.

“The SMP (bond programme) won’t be causing a U-turn,” Societe Generale strategists said in a note. “(It) has been on and off, and no longer looks like a tool that can durably affect market conditions - unless the ECB radically changes its communication and commitment.”

They also said that the ECB’s move to avoid taking losses on its Greek bonds made investors believe they will always be subordinate to the central bank and more bond purchases could exacerbate those concerns.

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