(Corrects day in first paragraph to Tuesday)
* Euro zone periphery govt bond yields: tmsnrt.rs/2ii2Bqr
By Elizabeth Howcroft
LONDON, July 21 (Reuters) - Euro zone bonds sold off on Tuesday, with Italy’s yields edging back up after hitting their lowest since the start of March in early London trading after European Union leaders agreed on a massive coronavirus recovery fund to support the bloc.
The EU agreed on the 750 billion euro ($860 billion) fund in the early hours of Tuesday 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 1.172% by 1457 GMT..
It was set to end the day up for the first time after seven consecutive sessions of falls.
Spreads between core and peripheral yields tightened, with the Germany-Italy 10-year yield spread near its narrowest in four months before widening again to around 162 basis points. .
“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 and Greek spreads over Germany also tightened.
German, French and Dutch yields edged up by about 1 basis point but were largely unchanged by the news. Germany’s benchmark 10-year yield at -0.454%, 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.
But European Central Bank Vice President Luis de Guindos said on Tuesday that a new wave of the coronavirus crisis in areas such as the United States, Latin America and some parts of Asia could drag down Europe’s growth.
ECB board member Isabel Schnabel was quoted on Tuesday as saying that investors should not read too much into ECB bond purchases falling, because they could increase later. She said that the ECB is likely to use its entire bond purchase quota. ($1 = 0.8707 euros)
Reporting by Elizabeth Howcroft; Editing by Alison Williams