* Italian and Spanish debt rallies after LTRO
* Analysts say peripheral yields should remain lower
* German Bund closes down, falling off record high
By Alessandra Prentice and Ana Nicolaci da Costa
LONDON, Feb 29 (Reuters) - Italian government bond yields slid to multi-month lows and Spanish yields fell after the European Central Bank’s second liquidity injection on Wednesday, with analysts expecting yields to stay lower provided growth prospects do not worsen.
Banks gorged on 530 billion euros ($711.45 billion) at the ECB’s offering of cheap three-year funds as part of its long-term refinancing operation (LTRO), a move investors hope will further ease tension in the banking sector. .
The extra cash in the system should also facilitate Italy and Spain’s access to market funding, with some in the market saying the countries’ cost of borrowing should remain cheaper so long as the economic or political outlook does not deteriorate.
“The LTRO should be supportive all round. There might be a risk of profit-taking in the near term, but it should be fairly temporary until we get any more substantive negative news,” said Chris Scicluna, deputy head of economic research at Daiwa Capital Markets.
“If things take a turn for the worse in terms of the growth story or political agenda there is scope for a correction,” he said.
Italian two-year debt yields fell to 2.20 percent , their lowest since November 2010, while 10-year yields eased to their lowest since September at 5.21 percent and have fallen more than 2 percentage points from euro-era peaks hit in November.
Spanish two-year debt yielded 2.45 percent, 11 bps less on the day while the 10-year equivalent was 6 bps lower at 4.99 percent.
“The two-year and three-year part of the curve is super rich because of the LTRO bid,” a trader said, referring to the Italian and Spanish curves.
“After today, our guess is that it should start seeing profit taking on this part of the curve or people putting on flatteners. So selling 2s and 3s and buying 5s and 10s.”
Bucking the trend, Portuguese 10-year yields surged 69 bps to 13.96 percent, prompting the ECB to step in to buy Portuguese government bonds in secondary debt markets, according to traders.
“The attractiveness of a country like Portugal that looks set fair for a second bailout just isn’t there. Even if you are awash with LTRO liquidity you would certainly think twice about investing in Portuguese government bonds,” Scicluna said.
ECB liquidity boosted German Bund futures to a new record high of 140.28, up 22 ticks on the day, but Bunds later lost ground, with prices falling 30 ticks to close at 139.76 as they tracked U.S. peers lower.
A German sale of 10-year bonds met decent demand even though it coincided with the announcement of the LTRO take-up, showing investor appetite for safe-haven debt remained intact even as riskier assets rallied.
Analysts said the underlying bid for Bunds was based on the view that ECB cash buys the euro zone time to gets its fiscal house in order but does not solve its debt problems.
Germany sold 3.26 billion euros of the paper at an average yield of 1.83 percent, just above the 1.82 percent seen in a sale on Feb. 1, and drew bids for 1.4 times the amount on offer, the same as at the previous auction.
“The auction went reasonably well given the very tricky environment right after the tender and it was basically a mirror-image of the last Bund auction,” said Michael Leister, a rate strategist at DZ Bank.
Ten-year German government bond yields were last 1.7 bps up at 1.79 percent.