UPDATE 2-Italian bonds bask in afterglow of recovery fund deal

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds move in Greek bonds, updates prices)

By Dhara Ranasinghe

LONDON, July 23 (Reuters) – Italy’s 10-year bond yield fell to 4-1/2 month lows on Thursday, heading closer to 1%, as growing confidence in the euro zone outlook following this week’s recovery fund deal boosted southern European debt.

Ten-year yields in Italy – the euro zone’s biggest sovereign bond market in terms of outstanding debt – have tumbled 18 basis points this week, set for their best week in two months. When a bond’s price rises, the yield falls.

The closely-watched gap between Italian and German 10-year bond yields hit 152 bps, its narrowest since late March.

Aggressive European Central Bank stimulus had already pushed down euro zone borrowing costs. This together with the 750 billion euro EU recovery fund have eased concerns about outlook for highly indebted Italy, one of the European countries hardest hit by the coronavirus.

“The ECB and now the recovery fund have ensured that structural concerns are no longer the key determinant of peripheral yields and spreads, which means that peripheral debt will perform in line with risky assets more broadly,” said Richard McGuire, head of rates at Rabobank.

“The agreement of the recovery fund has boosted risk appetite and thus prompted a further rally in peripherals but, conspicuously, unaccompanied by higher core yields. This, to us reflects the fact that fund is of symbolic importance more than it is reflective of debt mutualisation.”

Italy’s 10-year yield fell 4 bps to 1.056%, its lowest level since early March.

Five-year yields fell below 0.5% for the first time since early March; two-year yields briefly hit a 4-1/2 month low of -0.083%.

Bond yield spreads in France, Spain and Portugal have all narrowed this week versus Germany to their tightest levels in weeks.

A rally in Greek bonds has gained momentum, with 10-year yields falling to five-month lows at 1.08%

Germany’s 10-year bond yield meanwhile held near Wednesday’s two-month lows around -0.4870%, with safe-haven assets supported by renewed tension between the world’s biggest economies as Washington on Wednesday ordered Beijing to close its consulate in Houston.

ING senior rates strategist Antoine Bouvet said the fact that investors shrugged off positive news on a COVID-19 vaccine earlier this week but reacted to signs of U.S.-China tension reflected market positioning.

“To spell it out more explicitly, we suspect investors might be trying to pare back their risk exposure into the summer months,” he said.

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