* S&P currently rates Italy BBB with negative outlook
* Italy/Germany yield tightens after hitting 270.7 bps
* Spanish election this weekend
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates move in Italy, adds fresh comment)
By Abhinav Ramnarayan and Dhara Ranasinghe
LONDON, April 26 (Reuters) - Italy’s government bond yields fell sharply on Friday, pulling back from recent seven-week highs, on bets that S&P Global will refrain from downgrading the country at a ratings review.
S&P Global will review Italy’s sovereign credit rating after the market closes on Friday. It currently rates Italy BBB with a negative outlook. A downgrade to BBB- would put the rating just one level above junk. Italy is rated Baa3 by Moody’s and BBB by Fitch.
Unease about a ratings downgrade and tension within the ruling coalition had pushed 10-year bond yields to seven-week highs earlier this week, while the gap over benchmark German Bund yields briefly hit its widest in two months in early Friday trade.
But Italian bond yields fell as the session wore on, a move analysts attributed to a view that Italy was safe from a downgrade for now.
“I don’t think anybody has any inside knowledge on this so it is just speculation and markets are very thin,” said DZ Bank rates strategist Christian Lenk, adding that he believed that there could be a downgrade for Italy.
In late trade, Italy’s 10-year bond yield was down nine basis points on the day at 2.59 percent, down from seven-week highs hit on Tuesday at 2.70 percent and set for its biggest daily fall in seven weeks.
That pulled the Italian/German 10-year bond yield gap in from two-month highs around 271 bps.
“It doesn’t make a lot of sense for ratings agencies to be ahead of the curve, so I wouldn’t expect them to downgrade Italy today. It is possible that some investors are buying on this view,” said Mizuho strategist Antoine Bouvet.
Natixis rates strategist Cyril Regnat also said that S&P was unlikely to downgrade Italy later on Friday, though the wording of the accompanying statement could give the market an idea of where the rating was heading in the next six months.
Italy was not the only southern European bond market in the spotlight.
Spanish voters go to the polls this weekend in one of the most contentious elections in decades, with at least five parties in with a chance of being in the next government. The far-right party Vox is likely to win seats for the first time.
Yet Spanish 10-year yields also dropped, by about six bps to 1.03 percent.
“Spain has so far avoided a populist government, kept the country together, tackled corruption, and 67 percent of the population has a favourable opinion of the EU,” Indosuez Wealth Management said in a note.
“As long as Vox does not enter a governing coalition, the Spanish elections could actually deliver a fillip to European markets.”
S&P is also due on Friday to review Greece’s rating, currently B+, and a positive outlook suggests it may be upgraded.
Elsewhere, euro zone bond markets showed little immediate reaction to U.S. GDP data, with Germany’s 10-year Bund yield remaining below zero percent as worry persists over the region’s economy.
U.S. Treasury yields fell following Friday’s first-quarter growth report as weak inflation data tempered the strong headline figure. (Reporting by Abhinav Ramnarayan; Editing by Toby Chopra, Gareth Jones and Raissa Kasolowsky)