By Elizabeth Howcroft
LONDON, July 21 (Reuters) - Italian government bond yields fell to their lowest since early March after European Union leaders agreed on a massive coronavirus recovery fund, but the move was short-lived, with most euro zone yields edging up during the morning.
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. The agreement was cheered by markets as a significant step in shoring up euro zone economies against the COVID-19 shock.
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.
Italy's tourism-driven economy was among the worst hit by the virus. Prime Minister Giuseppe Conte said that 28%, or 209 billion euros, would be for Italy, giving the country the opportunity to "restart with strength".
The 10-year Italian government bond yield, which had already fallen 70 basis points in anticipation of the fund since it was first proposed on May 18, fell further on Tuesday morning. It hit 1.117% - its lowest since the first week of March - before recovering to 1.161% by 1049 GMT. IT10YT=RR.
Spreads between core and peripheral yields tightened, with the Germany-Italy 10-year yield spread near its narrowest in four months, down about 2 bps at 160.75 bps DE10IT10=RR.
"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. DE10PT10=RR, DE10ES10=RR, DE10GR10=RR
German, French and Dutch yields edged up by about 1 basis point but were largely unchanged by the news, with Germany's benchmark 10-year yield at -0.449%, having moved in a narrow 12 bps range so far this month.
"It is possible that Bunds' remarkable insouciance in the face of the peripheral rally reflects the fact that the liability sharing promised by the Fund is even more tokenistic than it appears," wrote Rabobank rates strategists.
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 Tuesday 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.
($1 = 0.8739 euros)
(Reporting by Elizabeth Howcroft Editing by David Goodman and Andrew Cawthorne)
((Elizabeth.Howcroft@thomsonreuters.com; +44 02075427104;))
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.