Italian bond yields fall to early March lows as potential for EU recovery fund deal grows


By Yoruk Bahceli

AMSTERDAM, July 20 (Reuters) - Italy's borrowing costs fell to their lowest since early March on Monday as signs of a potential agreement started to emerge from a fraught European Union summit aimed at agreeing a 750 billion euro economic recovery fund.

The proposed fund, which envisions liability sharing by offering grants to the worst-hit states, has been a key driver of a rally in Southern European bonds led by Italy since May, following an initial, similar Franco-German proposal.

The summit, originally scheduled for Friday and Saturday, stretched into Monday as fiscal hawk states led by the Netherlands balked at the size of grants to the worst-affected states and demanded handouts be conditional on economic reforms.

But signs emerged that a deal could emerge around the grants being reduced to 390 billion euros, a compromise between the 350 billion level the "frugal" states pushed for and the 400 billion euro minimum demanded by France and Germany. The summit was adjourned on Monday until 1400 GMT.

After markets last week judged prospects of a deal being struck over the weekend increasingly unlikely and expected a decision to be delayed, Italian bonds rallied on the surprise progress on Monday.

"I think more important than the size of the package at the moment is the fund being implemented (at all)," said Peter Chatwell, head of multi-asset strategy at Mizuho in London, who expected an accord might be sealed later on Monday.

Italy's 10-year yield fell to its lowest since March 9 at 1.19%, wiping out much of the coronavirus sell-off that drove it as high as 3%. It was last down 3 basis points on the day at 1.21% IT10YT=RR

That reduced the closely watched risk premium Italy pays for 10-year debt on top of Germany to its lowest since late March at 163 bps.

Markets have been encouraged by the potential compromise around grants appearing higher than what the frugal states demanded over the weekend, said Hetal Mehta, European economist at Legal & General Investment Management, which manages 1.2 trillion pounds.

"The fact that they have now moved onto a fourth day of negotiations shows real determination," she said.

"Just because they've reduced the grant size, they haven't reduced the overall size of the package. So, what they're planning on cutting on the grant side could actually be added to the loans component."

But Mizuho's Chatwell warned that negative headlines around conditionality could undo some of the gains in later trade.

"If there are more rigid and unpalatable conditionalities, which relate more to stability and growth pact-type conditions, or conditions which are normally associated with a bailout deal, that would hit the breaks on positivity."

Safe-haven German 10-year yields were up 2 basis points to -0.44% DE10YT=RR.

(Reporting by Yoruk Bahceli Editing by Mark Heinrich and Peter Graff)

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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