Italian yields fall to pre-crisis levels on EU recovery fund

LONDON: Italian government bond yields fell to their lowest since early March after European Union leaders agreed on a massive recovery fund to support European economies hit by the coronavirus crisis.

The EU agreed on the 750 billion euro ($858.2 billion) fund in the early hours of Tuesday morning after a prolonged summit that lasted almost five days.

Under a compromise deal the package will comprise 390 billion euros of grants - less than the originally targeted 500 billion euros - and 360 billion euros of cheap loans.

The 10-year Italian government bond yield fell to its lowest since the first week of March on Tuesday morning, dropping about 3 basis points to 1.128%.

Italy's tourism-driven economy was among those hardest hit by the crisis.

After spiking in mid-March, its government bond yields have been falling gradually since the recovery fund was first proposed on May 18.

Spreads between core and peripheral yields tightened, with the Germany-Italy 10-year yield spread at its narrowest in four months, down about 5 bps at 156.26 bps.

"With drawn-out negotiations having been avoided, we see the path cleared for the 10Y Italy-German spread going through our 150bp target this summer," ING strategists wrote in a note to clients.

"The carry benefit of peripheral debt, and lower prospective volatility thanks to the ECB intervention, make it a superior alternative to core bonds, in our view."

The Portuguese, Spanish and Greek spreads over Germany also tightened.

Spain's 10-year government bond yield fell to its lowest since March, down 3 bps at 0.338%.

German, French and Dutch yields edged up by about 1-2 basis points as the risk-on mood sparked by the EU agreement prompted an investor retreat from safer government debt.

Markets took confidence not only from the size of the fund itself but also from the demonstration of solidarity and debt-sharing between EU countries.

Total European Central Bank (ECB) bond purchase volumes fell last week, the ECB said on Monday.

But ECB board member Isabel Schnabel was quoted on Teusday as saying that investors should not read too much into this because purchases could increase later, adding that the ECB is likely to use its entire bond purchase quota.