Yields on lower-rated euro zone bonds fell on Friday after the European Central Bank fleshed out the terms of long-term loans it has lined up for banks and said it stood ready to print money if needed. The ECB will give banks the opportunity to borrow up to 1 trillion euros for four years at a rate of only 0.25 percent from September in the hope they will lend some of that money to businesses and consumers.
Peripheral bonds benefit from two aspects of the programme of targeted long-term refinancing operations (TLTROs). Firstly banks, which are still deleveraging - most of them based in those countries - will get easier terms. Secondly, some of the cash can be used to buy government bonds, and the only short-term debt yielding over 0.25 percent is peripheral.
"There was a fear that there could have been a greater degree of scrutiny about what the TLTROs would have to be used for and to a certain extent that fear has been appeased," said Padhraic Garvey, head of investment grade debt strategy at ING. "This adds to the support for peripheral yields." Spanish 10-year yields fell 3 basis points to 2.67 percent, while Italian 10-year bond yields fell 5 bps to 2.70 percent.
"I don't think the periphery story is over yet," said Marius Daheim, chief strategist at Bayerische Landesbank. "The market has taken some confidence from the ECB's statements that there will be liquidity around." Another factor contributing to the rally was that the ECB kept the possibility of fighting low inflation with a large-scale asset purchase programme on the table.
Irish 10-year yields fell 6 bps to 2.31 percent, with the bonds extending a rally following better-than-expected economic data on Thursday. German Bunds, the benchmark for euro zone borrowing costs, yielded 1.25 percent, 4 bps lower on the day. Portuguese bonds, which have underperformed this week due to concerns surrounding an investigation into holding companies of the country's largest bank, were flat on the day, with 10-year paper at 3.61 percent.
Analysts tips Portuguese bonds to outperform because their short-term debt has the highest yield in the bloc, attractive for banks looking to re-invest the ECB's new longer-term loans. Banks who cannot prove they have used the ECB money to lend to businesses can pay the cash back with no penalty after two years. That means that lenders can profit if they use the money to buy relatively high-yielding two-year government bonds.
At just over 1 percent, two-year Portuguese yields are double those of Spanish and Italian bonds. "Portugal has the potential to outperform," said Jan von Gerich, chief fixed income analyst at Nordea. "I don't think banks from the core will be going for the Portuguese bonds. But even if they don't and only the local banks are buying that would still help."
Yield differentials are much lower than in late 2011, when the ECB first offered banks cheap, unlimited three-year money with no conditions attached. The gains on offer for banks that invested in three-year Spanish, Italian and Portuguese bonds at the time ranged from 500 to 1,700 basis points, compared with 15-75 basis points based on current prices. But that would not deter some banks from buying bonds with the cash they borrow, some traders say. "At the end of the day what else are you going to do with your money? It's a safe, can't-lose bet," a trader said.
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