Southern European bond yields hit new lows on stimulus, EU solidarity

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, Aug 11 (Reuters) – Southern European government bond yields hit new lows on Tuesday as the promise of fiscal stimulus in the United States added to a heady cocktail that already included unprecedented central bank support and confidence in a European Union recovery fund.

Though talks between the U.S. Republicans and Democrats were suspended last week, markets retain hopes of a breakthrough, with the U.S. dollar holding on to overnight gains against a basket of currencies.

In quiet summer trading, Spanish and Portuguese borrowing costs dropped to new five-month lows while benchmark Italian 10-year bond yields remain below the 1% mark.

In the absence of significant data releases or Europe-related headlines to disrupt the mood, the recently agreed European recovery fund has encouraged investors to keep buying this kind of debt, said Mizuho rates strategist Peter Chatwell.

“That was a watershed moment. Investors can now look at all European government bonds as being much more similar as it is more likely that stronger economies will be able to support the weaker ones in a crisis via the recovery fund,” he said.

Spain’s 10-year government bond yield dropped to 0.254%, its lowest since early March, while the equivalent Portuguese bond yield hit 0.278%, also its lowest since early March.

The amount of central bank liquidity flooding the system is also pushing spreads tighter. Chatwell pointed to the difference between three-month Euribor and the Euro Overnight Index Average, which has gone negative for the first time since early March.

“This is a sign that there is so much liquidity in the system that banks are effectively saying they don’t need the money,” he said.

Later on Tuesday, Germany’s ZEW research institute will release its monthly survey of economic sentiment that should give an indication of how quickly investors expect the European economy to recover from the worst of the COVID-19 crisis.

Over in the UK, the difference between two and 10-year gilt yields were close to their lowest level since March as the outlook for the British economy remains uncertain, with the country suffering its worst job losses since 2009.

This spread – often seen as an indicator of the economic outlook – is also partly being flattened by the Bank of England’s seeming reluctance to commit to negative interest rates, analysts said. (Reporting by Abhinav Ramnarayan; Editing by Susan Fenton)

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