German bonds hurt as Merkel heads towards exit, Italy wins ratings reprieve

LONDON: German bond yields rose on Monday on growing political uncertainty in the euro zone's powerhouse economy, while Italy's borrowing costs fell sharply on relief that Standard & Poor's left its credit rating unchanged.

German Chancellor Angela Merkel has told senior members of her Christian Democrats (CDU) that she will not seek re-election as party leader at a conference in December, a senior party source said on Monday.

According to CDU sources, Merkel said she would not stand as candidate for chancellor or lawmaker after 2021.

Merkel has led the CDU since 2000 and giving up the role would start a race within the party to succeed her as German leader.

The news followed poor results for the CDU and its junior coalition partner at a weekend election in the western state of Hesse.

While German bonds, regarded as one of the safest assets in the word, often benefit from uncertainty, the implications of latest political developments left even German bond investors slightly rattled and the euro came under selling pressure, albeit briefly.

"This news would signal the quality of German credit would deteriorate because markets are extrapolating from the results of the weekend state election to conclude that the next government will have a bigger populist portion to it," said Mizuho rates strategist Peter Chatwell.

"So that explains the rise in German yields but there is also a need to treat German bonds as a risk-free (investment), so if there was a lot of stress a selloff would be limited."

Germany's benchmark 10-year Bund yield was up 4 basis points at 0.39 percent, well above seven-week lows hit last week at around 0.34 percent.

It was set for its biggest one-day jump in almost four weeks and was the clear underperformer in euro zone bond markets. Across the German curve, yields were up 2-4 bps on the day.

The selloff in German bonds and a firmer tone to European stock markets after a bruising few sessions last week was accompanied by rising yields for higher-rated euro zone bonds.

However, borrowing costs in Italy fell sharply - benefiting bond markets in Spain and Portugal, where yields also fell  .

That followed a decision on Friday by Standard & Poor's to leave Italy's rating unchanged at BBB, two notches above junk.

The ratings agency lowered the outlook for Italian ratings to negative from stable, saying that the new government's policy plans were weighing on the country's growth and debt prospects.

But the decision to leave the rating unchanged, a week after Moody's downgraded its rating, bought some relief to a bond market hurt by the spending plans of the new government in Rome, tension between it and the European Union.

Italy's 10-year bond yield fell to a one-week low at 3.31 percent, while the gap over top-rated German bond yields narrowed to 293 bps from around 306 bps late Friday .

"The ratings update was a relief," Commerzbank rates strategist Rainer Guntermann said. "The underlying budget concern is an ongoing issue but the ratings risks are out of the way for the rest of the year as there are no more scheduled ratings decisions."