Southern European yields reverse course; Italy ratings test looms

• Italian bond yields initially rose on Friday after EU leaders agreed to build an emergency fund to help states recover from the pandemic but gave no details of the size, speed and structure of the package.
• Spain's 10-year government bond yield was last down 7 bps at 0.979%, while Portugal's was down 8 bps -- also reversing earlier rises.

LONDON: Southern European bond yields fell on Friday, reversing an early rise, although a cautious tone in markets remained ahead of a S&P Global ratings review of Italy's debt later in the day.

Analysts said it was unclear why bond markets were recovering given disappointment following a European Union summit on Thursday but suspected that European Central Bank buying may have helped.

Italian bond yields initially rose on Friday after EU leaders agreed to build an emergency fund to help states recover from the pandemic but gave no details of the size, speed and structure of the package.

The leaders agreed late on Thursday in principle to a 1.5 trillion-euro rescue package to share the economic cost of the pandemic, which is falling disproportionately on southern European states. A decision on the details of the programme was delayed until the summer.

Italy's 10-year bond yield was last down 6 basis points, at 1.95%, having risen sharply in early days. Short-dated bond yields, which had jumped as much as 12 bps earlier, were a touch lower.

The Italian/German 10-year bond yield spread, which had widened to as much as 256.10 bps early on Friday, narrowed to 240.8 bps, still 3 bps wider on the day.

"It seems hard to rationalise because you had the disappointment following the EU meeting," said Richard McGuire, head of rates strategy at Rabobank, referring to the fall in yields.

"Maybe we can blame this composure on ECB intervention," he added.

Spain's 10-year government bond yield was last down 7 bps at 0.979%, while Portugal's was down 8 bps -- also reversing earlier rises.

The benchmark German 10-year government bond yield fell around 4 bps as investors sought safety. It was last at -0.47 .

Italy's bond market faces another test on Friday, with S&P Global set to review the country's BBB credit rating - just two notches away from junk territory.

A downgrade is considered unlikely, despite Italy's deteriorating debt outlook. Moody's said on Thursday that the pandemic will push Italy's public debt to record levels this year.

Rabobank rates strategist Lyn Graham-Taylor said there was a strong economic case for S&P to lower Italy's rating but rating agencies faced political pressure not to downgrade low-rated eurozone sovereigns.

"Our base case is that no change will be made but it's not based on an economic view or debt view at all - it's purely based on a reluctance by rating agencies to make politically unpopular moves," he said.

Fitch late on Thursday revised its outlook on Greece to stable from positive - the latest sign that the ratings outlook for euro zone sovereigns has worsened.

Elsewhere, the 3-month Euribor rate eased a touch but remained near four-year highs.