November 27, 2018 / 12:44 PM / in 5 months

UPDATE 2-Spain, Portugal yields hit two-month lows on Italy feel-good factor

* Hope Italians will adjust deficit target boosts optimism

* Spanish, Portuguese bonds near one-month lows

* German bonds briefly benefit from Trump trade rhetoric (Adds details, updates prices)

By Abhinav Ramnarayan and Tommy Wilkes

LONDON, Nov 27 (Reuters) - Spanish and Portuguese 10-year government bond yields touched their lowest level in around two months on Tuesday, as reports of Italy’s conciliatory stance on budget talks lifted broader sentiment.

The Italian government said on Monday it was sticking to its main 2019 budget goals for now as it awaited a cost analysis of its main spending measures. But Rome left open the possibility of eventually cutting its deficit target, a demand of the European Union.

Italian bond yields had dropped sharply on Monday and while shorter-dated bonds were more or less unchanged from those levels on Tuesday, the yield on the 30-year debt briefly dropped a further five basis points to a one-month low of 3.87 percent.

The drop in yields comes despite reports that EU government representatives are set to back the European Commission’s disciplinary move against Italy over its debt.

The price gains have spilled into Spanish and Portuguese bonds, with Spain’s 10-year yield dropping to a nearly two-month low of 1.524 percent, down 5 bps on the day.

“The rally in Italian yields has provided an updraft for its fellow southern European debt markets,” said Rabobank rates strategist Richard McGuire.

Portugal’s 10-year bond yield hit a more than two-month low of 1.851 percent, down 4 bps on the day.

Antoine Bouvet, rates strategist at Mizuho, said that with no fresh developments on Tuesday, the market was performing well, with “buying flow behind it rather than news”.

Southern European debt may also be benefiting as speculation grows that the European Central Bank will postpone the winding down of its quantitative easing programme as economic growth in the euro zone wanes.

Any extension of the ECB’s easy-money scheme could support investor demand for southern European bonds like those in Spain and Portugal.

Market expectations of an ECB interest rate rise in 2019 have been pushed back in recent weeks, with money markets no longer fully pricing in a 10-basis-point hike next year.

European Central Bank President Mario Draghi said on Monday the loss of growth momentum in the euro zone was mostly normal and not enough to derail plans to dial back stimulus further.

German bond yields earlier fell earlier on Tuesday to their lowest in almost three months after U.S. President Trump reignited fears about global trade conflicts, spurring demand for assets deemed safer.

Trump said on Monday he expected to raise tariffs on Chinese imports. He also said the United Kingdom’s agreement to leave the European Union could make U.S. trade with Britain more difficult, adding to investors’ worries.

The yield on German 10-year government bonds dropped 3 basis points to 0.33 percent, its lowest since early September, before pulling back to trade at 0.34, down 2 basis points on the session.

Other high-grade euro zone bond yields, such as those of the Netherlands and France, were down as much as 2-3 bps on the day, briefly touching their lowest since early September. (Additional reporting by Virginia Furness Editing by Sujata Rao and Mark Heinrich)

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