UPDATE 1-Italian bonds bask in afterglow of recovery fund deal

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts with move in Italian debt)

By Dhara Ranasinghe

LONDON, July 23 (Reuters) – Italy’s 10-year bond yield fell to fresh 4-1/2 month lows on Thursday, moving closer towards 1%, as growing confidence in the euro zone outlook following this week’s recovery fund deal boosted southern European debt.

Ten-year bond yields in Italy — the euro zone’s biggest sovereign bond market in terms of outstanding debt — have tumbled 17 basis points this week, set for their best week in two months. When a bond’s price rises, the yield falls.

The closely-watched gap between Italian and German 10-year bond yields touched 154.50 bps, its narrowest level since late March.

Aggressive European Central Bank stimulus had already helped push down borrowing costs across the euro zone. This together with the 750 billion euro EU recovery fund have eased concerns about the future of highly indebted Italy, one of the hardest hit Europe countries by the coronavirus.

“The ECB and now the recovery fund have ensured that structural concerns are no longer the key determinant of peripheral yields and spreads, which means that peripheral debt will perform in line with risky assets more broadly,” said Richard McGuire, head of rates at Rabobank.

“The agreement of the recovery fund has boosted risk appetite and thus prompted a further rally in peripherals but, conspicuously, unaccompanied by higher core yields. This, to us reflects the fact that fund is of symbolic importance more than it is reflective of debt mutualisation.”

Italy’s 10-year bond yield fell 3 bps to around 1.07% , its lowest level since early March.

Five-year debt yields fell below 0.5% for the first time since early March, two-year yields briefly hit a new 4-1/2 month low at -0.067%.

Bond yield spreads in France, Spain and Portugal have all narrowed this week versus Germany to their tightest levels in weeks.

Germany’s benchmark 10-year bond yield held near Wednesday’s two-month lows around -0.50%, with safe-haven assets supported by renewed tension between the world’s biggest economies as Washington on Wednesday ordered to Beijing to close its consulate in Houston.

ING senior rates strategist Antoine Bouvet said the fact that markets shrugged off positive news on a COVID-19 vaccine earlier this week but reacted to signs of U.S./China tension was a reflection of market positioning.

“To spell it out more explicitly, we suspect investors might be trying to pare back their risk exposure into the summer months,” he said.

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