Spain, Italy bond yields dip as BES contagion risk ebbs

LONDON: Spanish and Italian bonds extended gains on Tuesday as fears receded that troubles in Portugal's banking sector could spread to other peripheral countries.

Yields on Spanish and Italian bonds fell as investors reacted to weekend news that Portugal had bailed out its largest bank, Banco Espirito Santo, drawing a line under an issue that has shaken vulnerable peripheral debt in recent weeks.

"The periphery has been the main winner of the resolution of the Banco Espirito Santo saga," said Luca Cazzulani, a strategist at UniCredit.

Spanish and Italian 10-year yields dropped 2 basis points, to 2.68 and 2.48 percent respectively. Portugal's 10-yrar yield was flat at 3.65 percent, having been the euro zone's best performer on Monday as markets first reacted to the BES bailout.

Cazzulani cautioned, however, that volumes were very low and with many participants on summer vacation did "not reflect fully the entire community of markets".

Daily volumes in Italian bond futures dropped by almost two thirds over the weekend, according to Reuters data.

Elsewhere, Greek bonds edged higher, extending losses from Monday afternoon.

An initial dip lower in yields after ratings agency Moody's upgraded Greece by two notches to Caa1 from Caa3 late on Friday, was swiftly erased. Ten-year yields have shed over 15 bps since.

Brussels is considering scrapping the troika that supervises Greek reforms to allow Athens to pursue its own plan to bolster the economy in return for a drip-feed of debt relief, European officials say.

Incoming European Commission President Jean-Claude Juncker on Monday played down the option of an outright writing-off of part of the euro zone loans to Greece to make the country's debt more manageable.

Traders said the moves in Greek yields were exacerbated in light summer trading with only a couple of hedge funds seen selling Greek bonds.

In core markets, German bonds edged up 1 bps to 1.14 percent ahead of a raft of economic indicators which include June's euro area retail sales at 0900GMT.