Italian yields hit lowest since March on economic recovery hopes

Earlier in the day, yields were unchanged after euro zone inflation rose in June from a four-year low in May, defying expectations it would be stable, as the negative impact of low energy prices decreased. Hopes have risen that the ECB will settle its differences with Germany's Constitutional Court, which ruled last month the central bank must justify bond purchases under its stimulus plan or lose the Bundesbank as a participant.

Italian yields fell to their lowest since March on Tuesday as traders bet that stimulus from the European Central Bank was adequate protection against a second wave of coronavirus infections. Earlier in the day, yields were unchanged after euro zone inflation rose in June from a four-year low in May, defying expectations it would be stable, as the negative impact of low energy prices decreased.

Hopes have risen that the ECB will settle its differences with Germany's Constitutional Court, which ruled last month the central bank must justify bond purchases under its stimulus plan or lose the Bundesbank as a participant. The ECB has honoured the principle of proportionality with its flagship stimulus programme, German Finance Minister Olaf Scholz said in a letter to the president of Germany's lower house of parliament.

"This should contribute to boosting the credibility of the ECB's QE (quantitative easing) response and serve to maintain its benefits," said ING analysts in a note to clients. "As this debate is being settled, a new, more important one is about to take place - is the set of measures enough to shield markets and the euro zone economy from a second wave of COVID infections?" they wrote, adding: "we are inclined to answer in the negative."

While the overall COVID-19 death rate has flattened, health experts have expressed concerns about record numbers of new cases in some countries, including the United States, India and Brazil. However, Italian yields dropped on Tuesday. The 10-year bond yield was down 5 basis points to as low as 1.308%, its lowest since March 27.

The 30-year yield also hit its lowest since March while shorted-dated bond yields were close to three-month lows. Italian yields tend to rise when there is increased nervousness about the euro zone because the country is highly indebted, and the fall in Italian borrowing costs reflect increased confidence that policymaker initiatives will help the region to weather the worst of the virus-induced economic shock.

Lyn Graham-Taylor, fixed income strategist at Rabobank, said it was very difficult to read markets because of the "overwhelming influence" of central banks, which is likely to continue. "A second wave is unavoidable and the measures we've taken so far to deal with the current wave only emphasised the longer term concerns we have - the measures taken will promote inequality," she said.

"If anything, the huge increase in government debt will require central banks to keep yields low in order to keep it sustainable." Germany's 10-year bond yield, the benchmark for the euro zone, also fell to its lowest since March earlier in the day before steadying at -0.47%.

Long-term euro zone inflation expectations were at 1.1199%, highest since the beginning of March, according to the five-year, five-year forward rate, a market gauge of long-term expectations. This compares to 0.84% in mid-May and an all-time low of 0.7198% in March.

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