LONDON: Southern European government debt outperformed better-rated peers on Tuesday ahead of a survey of economic sentiment that could provide fresh evidence of a decline in euro zone optimism, which could in turn keep the ECB stimulus flowing.
The survey of economic sentiment by the ZEW institute in Germany, due at 0900 GMT, could provide another "nasty surprise", Commerzbank analysts said.
After a stellar 2017, optimism over euro zone growth this year so far has faded, boosting expectations that the European Central Bank will keep asset purchases going until the very end of the year, rather than stop in September as some had speculated, said ING strategist Benjamin Schroeder.
This boosts the case for buying Italian, Spanish and Portuguese debt, seen as beneficiaries of ECB largesse.
"As the ECB withdrawal is still many months away, many market participants will feel they may as well pick up the carry in the meantime," said Schroeder, meaning borrowing short-term cash at low rates and buying higher-yielding assets with it.
ECB chief economist Peter Praet said on Monday that, while he was confident that inflation in the bloc would pick up, an ample degree of monetary stimulus was still needed.
In addition, a majority of economists polled by Reuters believe euro zone economic growth will take a further hit from the ongoing trade dispute between the United States and China.
Spanish, Italian and Portuguese bond yields moved closer to benchmark German debt yields on Tuesday.
The Spain/Germany 10-year government bond yield gap hit its tightest level since April 6 at 70.5 basis points and the equivalent Portugal/Germany spread narrowed to 110 bps, also its tightest since early April.
"Also, with Bund yields at around 50 basis points, peripheral bonds become a bit more attractive in comparison," said Schroeder of ING.
The yield on Germany's 10-year government bond, the benchmark for the region, rose a touch to 0.53 percent on Tuesday, on some optimism that a wider geopolitical conflict will be avoided after US-led air strikes in Syria over the weekend.
But it is still not far from 2-1/2 month lows of 0.473 percent hit in recent weeks, and is well below the year's high of 0.81 percent.
This has made it a less attractive investment for investors who do not mind taking on the additional risk of buying lower-rated government debt such as Italy's, currently yielding around 1.80 percent.
Also on Tuesday, the UK is due to publish employment and wage growth data, which could affect Gilt yields as investors evaluate the likelihood of further rate hikes from the Bank of England.
This in turn could affect German Bund yields as many investors switch between the government debt of the world's major economies.
Sterling on Tuesday soared to its highest level since Britain's vote to leave the European Union in June 2016, boosted by rate hike expectations and hopes that Britain will avoid a disorderly Brexit.
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