May 20, 2020 / 11:12 AM / 8 days ago

UPDATE 2-Italian bonds react little to hawkish counter-proposal to recovery fund

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds commentary)

By Yoruk Bahceli

LONDON, May 20 (Reuters) - Italian bond yields held near 5-1/2 week lows on Wednesday, despite the prospect of a hawkish counter-proposal to a plan for a recovery fund offered by France and Germany.

A group of European Union states will propose funding coronavirus recovery efforts with loans, not grants, as the Franco-German plans for a 500 billion-euro fund call for, Austrian Chancellor Sebastian Kurz said on Tuesday. His Dutch, Danish and Swedish counterparts agree, Kurz said.

But Italian and southern European bond yields - which tumbled after the announcement of the Franco-German proposal on Monday - showed little reaction.

“I wouldn’t underplay the significance of the developments. The fact that Germany, at least (Chancellor) Angela Merkel, is willing to cross the red line of a de facto pooling of finances, is certainly very, very significant,” said Richard McGuire, head of rates strategy at Rabobank in London.

Italy’s 10-year bond yield was up only 1 basis points at 1.65%, near the five-and-a-half-week lows reached after France and Germany made their proposal. It is down 20 basis points compared to the start of the week.

The risk premium it pays - the gap between it and Germany’s 10-year yield - was at 210 basis points, around 6 basis points wider than Tuesday’s five-week lows.

McGuire said that the European Central Bank’s emergency bond purchase programme PEPP was distorting the market, as they have been skewed towards Italian debt.

“It’s not just the risk of Italian debt that you need to look at when considering BTPs and the market’s reaction function... it’s expensive to short Italy, it’s profitable to go long and the ECB is distorting the market through the PEPP,” he McGuire.

“When you put all those together, there’s a tendency to emphasize good news and try to discount bad news,” he added.

Safe-haven German 10-year yields were flat at -0.46% but are up around 6 basis points this week.

Elsewhere Germany raised 4 billion euros via a re-opening of a 10-year bond, while France issued 11.24 billion euros of three-year, six-year and inflation-linked bonds.

Focus was also on the allotment of the European Central Bank’s first PELTRO - its emergency loan scheme announced last month as part of its efforts to cope with the coronavirus pandemic, where 851 million euros were allotted, even less than the small take-up analysts expected. (Reporting by Yoruk Bahceli, additional reporting by Elizabeth Howcroft, editing by Larry King and Timothy Heritage)

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