Southern European government bonds rally on EU recovery plan proposal

Southern European bonds rallied on Wednesday with yields falling to their lowest in around two months as the European Commission proposed to mobilize a 750 billion euro ($823.43 billion)recovery fund for the region's coronavirus-hit economies. Debt from the worst-hit regions rallied as the European Commmission proposed to offer 500 billion euros in grants and 250 billion euros in loans in a recovery fund as part of its next budget - worth 1.85 trillion euros

The plan builds on the 500-billion-euro proposal from France and Germany last week, which boosted demand for Italian government debt - expected to be one of the main beneficiaries. "This is supportive for risk sentiment in European fixed income," said Peter Chatwell, head of multi-asset strategy at Mizuho.

"I would suspect that, because there is a loan component in there, that this is something which helps to breach the gap between what the 'frugal four' were advocating, what the Franco-German proposal was advocating, and also what the real COVID-19-stricken economies actually need," he said. The so-called "frugal four" EU states - the Netherlands, Austria, Denmark and Sweden - would rather see the recovery package comprise only loans.

Italy's 10-year bond yield fell to an eight-week low at 1.463% and was last down 6 basis points on the day at 1.49%. The German-Italian 10-year yield spread narrowed to as low as 189 bps. Spain and Portugal's 10-year government bond yields fell to two-month lows and were last down 6 bps on the day .

Germany's benchmark 10-year yield hit new five-month highs when details of the European Commission's plans were confirmed . Elsewhere, European Central Bank President Christine Lagarde said on Wednesday the euro zone economy is likely to shrink between 8% and 12% this year as it struggles to overcome the impact of the coronavirus pandemic.

Antoine Bouvet, senior rates strategist at ING, said that the budgetary benefit from the fund would only be small relative to countries' needs after the pandemic and that quantitative easing would have a bigger market impact. "The headline suggest a larger package than anticipated (250 billion euros of loans on top of the 500 billion euros of grant in the Germany-France plan). However the plan still needs to be discussed by the 27 member states and we know little of how the funds will be allocated between countries," he said.

In the primary markets, France sold 7 billion euros of 20-year bonds via a syndicate of banks, for a yield of 0.525%, according to a pricing sheet seen by Reuters. The sale had been well awaited as France remained absent from a coronavirus syndication spree by euro zone governments. The format helps borrowers tap a larger investor base in bigger size. ($1 = 0.9108 euros)

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