Spanish debt rallies as Draghi sparks bond buying hopes

LONDON (Reuters) - Spanish and Italian government bond yields fell sharply on Thursday after European Central Bank President Mario Draghi fueled expectations that the central bank may be ready to take bolder action to combat the three-year old crisis.

Draghi pledged on Thursday to do whatever was necessary to protect the euro zone from collapse, including fighting unreasonably high government borrowing costs.

His comments also knocked the German Bund future sharply lower.

Still, the rally failed to bring 10-year Spanish yields much lower than 7 percent, which is widely seen as an unsustainable level in the long run. The ECB's previous forays into secondary markets had limited impact and could not prevent Greece, Ireland or Portugal from having to ask for financial help.

Unless stronger measures are taken, markets will continue to worry that Spain may eventually need to be bailed out and the euro zone's aid resources will be used up.

"Markets now feel that the most likely scenario is that the ECB will buy bonds in the market," ING rate strategist Alessandro Giansanti said.

"They can produce a relief rally so that Italy and Spain can issue bonds in the market for the next two months. But longer-term you need structural support. To see a decline in spreads you need better data on the economic side in Spain and Italy."

Ten-year Spanish yields were last 40 basis points lower on the day at 6.996 percent, some 565 basis points over their German equivalent. Italian yields fell 39 basis points to 6.05 percent.

Giansanti said the rally will only continue if the ECB would follow through with its warnings.

The timing of Draghi's comments a week before the ECB meeting will probably ensure that selling pressure does not build up either. Also, they come one day after his colleague Ewald Nowotny said giving Europe's permanent rescue fund a banking license to boost its firepower had merits.

"(The comments were) suggesting that the ECB could be a bit closer to a policy response than apparently the market thought before," Rainer Guntermann, strategist at Commerzbank said.

"I doubt the expectation for another rate cut would have triggered this kind of market response," he said. The expectation is for "something bolder than that, SMP-style intervention (bond-buying) or liquidity measures."

GERMANY'S CATCH-22

German Bunds also fell sharply as Draghi's comments prompted investors to move some cash into riskier assets.

Also, a warning on Germany's credit rating this week was a reminder of its vulnerability to the regional problems that are also beginning to take a toll on its export-led economy.

Steps towards a crisis-resolution are likely to see investors re-evaluate Germany's current yield levels which are near record lows and in the two-year sector is even negative.

German 10-year bonds last yielded 1.32 percent, up 5 basis points on the day.

Sergio Capaldi, strategist at Intesa SanPaolo, said Bunds should continue to benefit from safe-haven flows and 10-year yields could fall as far as 1 percent.

Without safe-haven flows into German debt, 10-year yields would probably stand around 2.2 percent, Capaldi said before Draghi began to speak.

"The Bund and also the Treasury (U.S. note future) are mainly overvalued but of course this is the effect of flight-to-quality in Europe and in the U.S., it's the combination of flight to quality and Fed intervention," Capaldi said.

Bund futures were 69 ticks lower on the day at 144.00. ING says the area between the 50-day moving average at 143.60 and 144.00 could provide support for Bunds on a short-term basis.

(Editing by Hugh Lawson)

Source: http://news.yahoo.com/spanish-debt-rallies-draghi-sparks-bond-buying-hopes-155356471--finance.html

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