July 25, 2014 / 3:50 PM / 5 years ago

Spanish yields hit record low before bumper debt repayments

(Updates prices, adds auction schedule)
    By Marius Zaharia
    LONDON, July 25 (Reuters) - Spanish bond yields fell to
record lows on Friday on expectations that 60 billion euros ($81
billion) worth of debt and coupon repayments from Spain and
Italy will be reinvested in those markets next week.
    A downbeat Ifo German business survey rekindled speculation
of further European Central Bank policy moves, offsetting the
selling pressure on euro zone bonds that came after better than
expected manufacturing and services sector surveys on Thursday.
    The ECB cut all its interest rates last month and promised
up to 1 trillion euros in long-term bank loans from September,
but it had not ruled out an asset-buying programme eventually if
inflation remains low for too long.
    German business sentiment fell for a third consecutive month
in July, suggesting firms in Europe's largest economy are
getting worried about the crises in Ukraine, Iraq and Gaza.
    "The Ifo results confirm a breakdown under way in the main
engine of euro zone growth, which raises the ... risk that
Russia sanctions may expose weak pockets in the euro zone
recovery and challenge the power of recent ECB announcements,"
said Lena Komileva, chief economist at G+ Economics.
    Spanish and Italian 10-year
yields dropped 3 basis points to 2.53 percent and 2.70 percent
respectively, before paring some of those gains in the
    German 10-year Bund yields, the benchmark for
euro zone borrowing costs, also fell 3 bps to 1.15 percent.
    Based on the redemption and debt auction schedule over the
summer, UBS strategists recommend buying three- and seven-year
Italian bonds against five-year paper and selling three-year
Spanish bonds for similar-dated Italian paper.
    The rationale is that the three- and seven-year Italian
bonds would benefit from the fact that repayments are larger
than the amount that is likely to be sold at auctions.
    Italy is the only euro zone sovereign bond issuer next week,
when it holds two separate auctions, but has cancelled its
mid-August auction. 

    Money markets were expected to be calmer in the coming week
after a steady rise in rates in the past few days.
    Data showed on Friday banks will repay only 3 billion euros
of long-term loans to the ECB next Wednesday, down from 21
billion euros this week and compared with a forecast of 5.8
billion in a Reuters poll.
    Rabobank strategists said they expected repayments to slow
in coming months as banks grow more relaxed that they can swap
their current loans for the ones the ECB plans to offer from
    "However... we would want at least two more low repayment
numbers before we become really confident on this view," they
said in a note.
    The small repayment next week should in theory keep excess
liquidity in the euro zone banking system above 100 billion
euros for the time being, preventing any stress in interbank
    "We expect Eonia rates to settle into quite a narrow range,"
RBS rate strategist Harvinder Sian said, referring to the euro
zone's overnight bank-to-bank borrowing rate.

($1 = 0.7445 Euros)

 (Reporting by Marius Zaharia; Editing by Hugh Lawson and Raissa
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