July 16, 2018 / 7:44 AM / 5 months ago

Euro zone yields near lows as China slowdown puts trade war in focus

* Safety bid keeps euro zone yields hover near lowest in weeks

* Focus on Powell speech as investors fret on tariff impact

* Italian short-term borrowing costs drop after Savona news

* Italian debt sustainability not a worry, says DBRS

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, July 16 (Reuters) - High-grade euro zone bond yields hovered near recent lows as softening Chinese growth kept investors wary about the potential global economic impact of a potential trade row between the United States and other major countries.

China’s economy expanded at a slower pace in the second quarter as Beijing’s efforts to contain debt hurt activity, while June factory output growth weakened to a two-year low in a worrying sign for investment and exporters as a trade war with the U.S. intensified.

Better-rated euro zone government debt usually benefits from a flight to safety in troubled times, and their yields — which move inversely to price — on Monday remained close to their lowest levels in weeks, and in some cases, months.

“The question is what happens when tariffs spill over into real data. I heard my economist saying that some of the Fed regional reports already point to some worries there,” said ING strategist Benjamin Schroeder.

“So this makes the Powell speech important this week, if he makes any comments on how the trade tariffs may affect the U.S. economy,” he said, referring to U.S. Federal Reserve chair Jerome Powell’s scheduled testimony to lawmakers on Tuesday.

Benchmark euro zone bond yields were mostly flat or marginally higher on Monday, with Germany’s 10-year government bond yield unchanged at 0.28 percent.

Some investors are now treating a recently issued German August 2028 bond as the new 10-year benchmark; that bond was yield 0.34 percent on Monday.

French and Belgian 10-year benchmark yields rose slightly, but were still close to their lowest levels since at least early January hit on Friday.

ITALY RELIEF

Elsewhere, Italy’s EU Affairs Minister Paulo Savona is reported to have said that Italy has proposed to the EU to be allowed to spend an extra 50 billion euros, which is approximately 2.7 percent of the country’s GDP.

Given that this figure is lower than many had feared, Italian yields came off the morning’s highs and 10-year yields turned flat on the day while two-year yields were lower 5 basis points to a near two-week low.

“Fiscal risks have increased, but measures intended to revamp growth are most likely to be implemented gradually and prudently,” analysts at ratings agency DBRS said in a statement that came out ahead of the Savona headlines.

The agency said it is unlikely that expected deviations from current fiscal targets undermine Italy’s public debt sustainability materially. (Reporting by Abhinav Ramnarayan Editing by Keith Weir)

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