* Euro zone govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)
By Olga Cotaga
LONDON, April 23 (Reuters) - Italian government debt yields fell on Thursday on hopes that European Union leaders would make progress in agreeing a joint recovery fund to fight the impact of the coronavirus.
Italy’s yields and the risk premium it pays on its debt had risen on Wednesday amid uncertainty over how the already heavily indebted country will pay for its stimulus plans.
Divided European Union leaders began their search on Thursday for a joint financial fund of up to 2 trillion euros ($2.16 trillion) to help recover from the coronavirus pandemic and avoid economic collapse in the poorer south, including Italy.
Italian debt was also supported by the European Central Bank’s decision on Wednesday to let banks post collateral that was downgraded to junk during the coronavirus outbreak, to prevent a credit squeeze in the euro zone.
Italian two-year government bond yields were down 11 basis points at 0.98% after rising as high as 1.26% on Wednesday . Ten-year yields were down 10 bps to 2.01% .
With the euro zone economy reeling, Italy is in danger of losing its investment-grade credit rating. That would have kept banks from using Italian bonds to finance themselves at the ECB, raising their borrowing costs prior to the ECB’s decision.
The ratings are in focus as S&P - which rates Italy just two notches above junk - is due to review the country’s rating on Friday.
EU leaders are likely to give the EU executive arm until around the end of April to decide the size of the recovery fund and how to finance it. The sums floated before the summit are huge, ranging from 1 trillion to several trillion euros. How to raise the funds and whether they should be loans or grants are contentious issues.
The prolonged negotiations over the economic package was “classic Europe”, said Iain Stealey, international CIO for fixed income at J.P. Morgan Asset Management.
“It naturally takes a bout of volatility and stress for everyone to come together.... Ultimately there will be a commitment to come together,” he said. “We expect we will see tighter Italian spreads over the longer term. But we might see higher spreads in the near term.”
Andy Cossor, a rates strategist at DZ Bank, said he thought the reason behind Italian yields falling was that the ECB might have been buying the country’s debt.
He said an ECB tactic was to avoid being seen to buy a country’s bonds on a day when the country issues new ones. Italy sold its first bond since the outbreak of the coronavirus crisis on Tuesday.
It was not issuing any bonds on Thursday, but was expected to do so on Friday, Cossor said.
Elsewhere, Italy’s economy minister said on Thursday he expected a “strong rebound” in output in the third quarter of the year and significant growth in 2021, after contraction caused by measures to fight the coronavirus.
Yields in core euro zone markets were down slightly too, though German 10-year Bund yields were down 1 basis point at -0.43%.
Germany’s coalition parties on Thursday agreed to further measures worth some 10 billion euros ($10.81 billion) to protect workers and companies. ($1 = 0.9240 euros)
Reporting by Olga Cotaga Additional reporting by Tommy Wilkes Editing by Peter Graff and Lisa Shumaker