March 18, 2020 / 12:13 PM / 4 months ago

UPDATE 2-Italian bond yields jump, central bank intervention brings some calm

(Updates with more details, analyst comment, chart)

By Dhara Ranasinghe, Abhinav Ramnarayan and Yoruk Bahceli

LONDON, March 18 (Reuters) - Italy's borrowing costs soared on Wednesday, briefly jumping above 3% for the first time in over a year, before reports the Bank of Italy was buying bonds bought some calm to panicked markets.

Italy, at the centre of coronavirus outbreak in Europe, saw its 10-year government bond yields more than 60 basis points up at one point, while the closely-watched spread over Germany ballooned to almost 320 basis points.

Analysts said the spike in bond yields, not just in Italy but across southern European bond markets, was triggered by very poor market liquidity that exacerbated the price moves.

Yields came down from their highs following a source-based report that the Bank of Italy was buying Italian paper as the system of euro zone central banks intervened to ensure orderly conditions in bond markets.

Italy's 10-year bond yield was last trading at 2.68% , down from highs above 3% but still up 30 bps on the day. Spanish and Portuguese 10-year bond yields were also more than 20 bps higher on the day each .

Richard McGuire, head of rates strategy at Rabobank, said the ECB's asset purchase programme (APP) gave the central bank flexibility to front load purchases when needed.

"Given their flexibility in the APP they can frontload their purchases so that may be precisely what they are doing, contrary to what (ECB chief Christine) Lagarde said, that the ECB doesn't control spreads," he said, referring to a comment made by Lagarde last week.

"It would appear from this action that they are doing just that. But this is only a short-term solution...The concern remains that the sizeable fiscal responses we are seen are being undertaken at a national level and that only accentuates credit risk on the part of more heavily indebted euro zone members."

Bond strategists said the sharp jump in yields and bond spreads in the past week raised the prospect of the ECB having to ramp up asset purchases focus on sovereign bonds.

The ECB's decision to shift asset purchases towards corporate bonds has weighed on government bonds markets.

The Italian/German 10-year yield gap has blown out 100 bps in the past week alone.

Earlier, Spanish and Portuguese 10-year bonds yields jumped to their highest levels since early 2019, while Greek 10-year bond yields shot above 4% and were last up 45 bps on the day.

"In Italy, yields are now rising to a point where investors are worried about debt sustainability and possibly euro break up risks," said Antoine Bouvet, senior rates strategist at ING.

Already the bloc's most fragile economy, Italy has been dealt a blow by the coronavirus outbreak that has forced a lockdown.

The toll on the economy will worsen the country's debt profile, putting upward pressure on its borrowing costs.

"If the ECB is not concerned about bond spreads, then one can conclude that fiscal easing will be at risk of causing more fragmentation and would be at risk of putting Italy's bond yields in an unsustainable level for their debt," said Peter Chatwell, head of rates at Mizuho.

"We are close to having the market pricing in a jump to default risks for Italy."

As Italy's bond yields soared, banks - which hold almost a sixth of the country's public debt - took a beating. Italian banking stocks slumped 3.6%, underperforming the broader market. (Reporting by Abhinav Ramnarayan and Dhara Ranasinghe and Yoruk Bahceli; editing by Philippa Fletcher)

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