LONDON: Spanish and Italian yields fell on Tuesday as a bailout deal for Greece insulated lower-rated euro zone bonds from a flight to safe havens triggered by China's devaluation of its yuan currency.
A Greek Finance Ministry official said the pact with international lenders would be worth up to 85 billion euros ($94 billion) in fresh loans over three years. Crucially, it will save Athens from default on a debt repayment of 3.2 billion euro due to the European Central Bank on Aug. 20.
Greek 10-year yields fell almost one percentage point to 10.29 percent, while two-year yields dropped nearly five percentage points to just below 15 percent.
In a global flight towards top-rated assets, which pushed yields on benchmark Bund yields and US Treasuries 7-10 basis points lower and weakened stock markets in Europe and Asia, the Greek deal meant peripheral bonds held strong.
The yuan devaluation raised concerns about the extent of the economic slowdown in the world's second biggest economy and its knock-on impact on other regions.
"The Chinese devaluation was taken as 'things are not going that well in China' and this is a risk-off move," said Martin van Vliet, senior rate strategist at ING.
"With the Greek deal secured and the ECB continuously buying bonds, peripheral spreads would have been much tighter otherwise." Spanish and Italian 10-year yields fell 5 basis points each to 1.93 percent and 1.78 percent respectively, while Portuguese equivalents dropped 8 basis points to 2.34 percent.
The fact that a slowing Chinese economy may dampen inflation prospects in the euro zone stoked expectations the ECB could provide more stimulus than the planned trillion-euro bond buying programme running until September 2016.
"With China slowing down, you see oil and other basic materials (prices) collapsing and this will exert downward pressure on headline inflation," said Sergio Capaldi, fixed income strategist at Intesa Sanpaolo.
"There is a need to further improve the expansionary position of the ECB's policy. In the case of more weakening in inflation we could see additional measures."
The ECB's preferred measure of the market's long-term inflation expectations, the five-year, five-year breakeven forward, traded around its lowest in two months, just above 1.7 percent.
One-year euro zone inflation swaps dropped below 0.20 percent on Tuesday, the lowest in over five months, and down from almost 1 percent in June. In the past month, markets have pushed back expectations of when the ECB will start normalising its policy by a whole year, to 2019.
The yuan move, aimed at boosting the economy, in fact exacerbated concerns about it.
"It's a reflection of how concerned Chinese authorities are about the economy, which is slowing faster than expected," said Nick Stamenkovic, bond strategist at RIA Capital Markets.
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