Italian bond yields set for biggest monthly fall in over two years

LONDON: Italian bond yields were set to record their biggest monthly fall in over two years on Friday, as Greece's latest crisis recedes and the euro zone struggles to rid itself of the spectre of deflation.

Since Greece reached an 11th-hour deal with creditors on July 13, accepting a new round of austerity measures in return for talks on a third bailout, its prime minister Alexis Tsipras has managed to contain a far-left backlash in Athens.

The ruling Syriza party backed a call on Thursday from Tsipras to push an emergency congress to September, a move that may buy the government time to conclude negotiations with lenders over a proposed 86 billion euro aid package.

This has brought relief to investors in other low-rated debt, of which Italy has the largest and most liquid market, while it has allowed attention to return to the scale of the stimulus needed from the European Central Bank to nurture the euro zone's recovery.

While growth in some corners of the currency union, such as Spain and Ireland, is impressive, it is anaemic inflation that is leading investors to speculate the ECB may have to extend its new bond-buying programme beyond its September 2016 end date.

Data on Friday showed euro area consumer prices rose 0.2 percent, coming well short of the ECB's target of just below 2 percent.

While the data matched expectations in a Reuters poll, some had expected an even weaker print after reports of a mere 0.1 percent reading in Germany and the return of negative inflation to Spain in July.

"In view of the recent decline in oil prices and of the ECB's observation that it would seem to be too early to already detect a trend reversal leading to higher inflation rates, worries about a renewed relapse into deflation are likely to persist," said DZ Bank's Felix Herrmann.

"This should, in general, constitute a stabilising factor for EMU (euro zone) bond markets over the next few weeks."

Italian 10-year bond yields edged up 1 basis point on Friday to 1.83 percent, after the euro zone data beat some more conservative expectations.

But the yield remains firmly on track for a fall of more 50 bps this month -- its best run since April 2013. Italian bonds outperformed German equivalents, the bloc's benchmark, which rose 5 bps to 0.66 percent but could not match a fall in Greek yields of some 11 bps to 12.12 percent.