UPDATE 1-European credit spreads widen as virus selloff resumes

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LONDON, March 18 (Reuters) - The cost of insuring against default for low-grade European bonds climbed further on Wednesday as a rollout of large scale support measures failed to diminish investor concerns about the wider impact of the coronavirus outbreak on the real economy.

Italian bonds came under special punishment with yields on benchmark 10-year government debt briefly rising by 56 bps, its biggest single day rise since the 2011 eurozone financial crisis as traders complained about shrinking market liquidity.

The blowout in spreads comes at a time when central banks have stepped up their liquidity injection measures as investors worried how would bond markets absorb the potential new supplies from more stimulus measures.

“We are in the midst of mayhem really, and I think there is still a risk that the increasing number of infections will keep markets on their toes,” said Hans Peterson, global head of asset allocation at SEB Investment Management.

Nordea analysts said in a note the European Central Bank’s monetary policy transmission is being impaired by the ballooning spreads and more support measures will put upside pressure on bond yields.

The European Central Bank stepped up its dollar funding operations on Wednesday, injecting $112 billion through twin term lending operations.

While those liquidity injections triggered a pull back in money market spreads, analysts were divided on whether this could be sustained as the dollar shortage this time around seems to wider than just with the countries the U.S. Federal Reserve has swap lines with.

The iTraxx Europe crossover index of credit default swaps (CDS), which measures the cost of insuring exposure to a basket of sub-investment grade European companies, jumped 35 bps from Tuesday’s close to 645 bps, data from IHS Markit showed.

Five-year credit default swaps for European lenders also rose with UniCredit and Deutsche Bank both adding 7 bps to 237 bps and 143 bps respectively. (Reporting by Karin Strohecker; Writing by Saikat Chatterjee; editing by Marc Jones and Angus MacSwan)