LONDON: Spanish government bond yields fell as expectations mounted that Moody's will upgrade the national credit rating later on Friday. In a sign of its strengthening economy, Madrid this week announced it was lowering this year's net debt issuance target to 48 billion euros from 51 billion -- a move seen as positive for its rating.
Moody's rating of Baa2 is one notch below the other two main agencies and it has held a positive outlook on the sovereign since February 2014.
Fitch upgraded Spain to BBB+ in April, while Standard & Poor's raised its rating to BBB+ two weeks ago.
"Spain is firmly on an upward path with its ratings. And thanks to a solid rebound in domestic growth, that should continue to be the case," Commerzbank strategist David Schnautz said. Spanish 10-year yields fell 4.3 basis points on Friday to 1.77 percent, approaching a five-month low.
Italian and Portuguese yields fell a similar amount, with Italian papers hitting a five-and-a-half month low. Earlier, Italy's Treasury debt management said that the country expects gross debt issuance in 2016 to be lower than this year's goal of 410-415 billion euros ($466-$471 billion).
These peripheral bonds outperformed their euro zone peers and EU benchmark German 10-year Bund yields fell 1.2 basis points to 0.54 percent.
The downward pressure on yields came from increasing expectations that the European Central Bank could ramp up its trillion-euro bond-buying programme and from weak European economic data.
Inflation in the euro zone slipped below zero for the first time since March, with prices falling 0.1 percent year on year.
LOOMING POLITICAL RISK
Spain has left behind recession and is now growing at one of the fastest rates in the euro zone. However, the European Commission warned this week that its macroeconomic projections forming the basis for its 2016 budget appeared "somewhat optimistic" and its budget risks breaking EU fiscal rules. Nearly one in four Spanish workers is unemployed and, like much of the euro zone, consumer prices are in decline.
A potential stand-off with the EU over the budget could become a problem for the ruling centre-right party with national elections due in December.
And despite the vote share in Catalonian regional elections last month suggesting that Catalans remain in favour of staying within Spain, the independence issue is not over yet, analysts said. These economic and political risks mean ratings agencies may show some restraint on further upgrades.
Commerzbank, which is expecting Moody's to upgrade Spain's rating with a positive outlook, said investors should not be disappointed if it leaves a stable outlook on the rating.
There are certainly signs of caution in the market. Despite its better economic record, Spanish 10-year yields are some 17 basis points higher than Italian equivalents, having been 25 bps below at the start of the year. This gap, however, has narrowed since the Catalonian election last month.
"Economically Spain is doing well, so it's a matter of whether any sort of problem from the political arena could then spill over into the economic reform process and therefore jeopardise the achievements that have been made so far," said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers.
Belgium and Germany are scheduled to sell new debt at auction in the coming week, while Cyprus may also issue bonds via a syndicate of banks.
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