Italian bond yields recorded their biggest monthly fall in more than two years on Friday, as Greece's crisis recedes and the euro zone struggles to rid itself of the spectre of deflation. Euro zone bond yields were also subdued after a record-low rise in US employment costs in the second quarter prompted investors to dial back bets the Federal Reserve would raise interest rates as early as September.
The general mood in euro zone bond markets has been firm since Greece reached an 11th-hour deal with creditors on July 13, accepting a new round of austerity measures in return for talks on a third bailout. Its prime minister, Alexis Tsipras, has managed to contain a far-left backlash in Athens. The ruling Syriza party backed a call on Thursday from Tsipras to push an emergency congress to September, a move that may buy the government time to conclude negotiations with lenders over a proposed 86 billion euro aid package. This has brought relief to investors in other low-rated debt, of which Italy has the largest and most liquid market, while it has allowed attention to return to the scale of the stimulus needed from the European Central Bank to nurture the euro zone's recovery.
While growth in some corners of the currency union, such as Spain and Ireland, is impressive, it is anaemic inflation that is leading investors to speculate the ECB may have to extend its new bond-buying programme beyond its September 2016 end date. Data on Friday showed euro area consumer prices rose 0.2 percent, coming well short of the ECB's target of just below 2 percent. While the numbers matched expectations in a Reuters poll, some had expected an even weaker print after a 0.1 percent reading in Germany and the return of negative inflation to Spain in July.
"In view of the recent decline in oil prices and of the ECB's observation that it would seem to be too early to already detect a trend reversal leading to higher inflation rates, worries about a renewed relapse into deflation are likely to persist," said DZ Bank's Felix Herrmann. "This should, in general, constitute a stabilising factor for EMU (euro zone) bond markets over the next few weeks." Italian 10-year bond yields fell up 5 basis points on Friday to 1.78 percent, taking its decline this month to 55 bps - its best run since April 2013. Spanish equivalents were down 7 bps at 1.85 percent but they have fallen slower than their Italian peers over the month.
Italian bonds outperformed German Bunds, the bloc's benchmark, whose 10-year yields inched up a touch to 0.62 percent, but could not match Friday's fall in Greek yields of some 11 bps to 12.12 percent. An estimated 30 billion euros in coupon payments and bond redemptions mainly from Italy is due next week, outstripping net supply nearly three times. "Quantitative easing and abundant redemptions should supoprt the periphery. In addition, August is typically a bond-friendly month. We expect yields to return under pressure only after the summer," UniCredit strategists said in a note.
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