Spain’s Bonds Post Best Week Since 2012 Amid QE Speculation

(Bloomberg) -- Spain's 10-year government bonds posted their best week in almost four years amid speculation the nation's securities would be among the main beneficiaries of any European Central Bank plan to loosen the rules for its bond purchases.

Spanish two- and 10-year yields dropped to all-time lows Friday as bonds extended their rally since last weekend's general elections, when acting Prime Minister Mariano Rajoy defied opinion polls to consolidate his position.

Italian sovereign securities also jumped this week, as the prospect of a deeper economic slowdown globally in the wake of Britain's vote to exit the European Union fueled wagers on additional central-bank easing. The rally was underpinned Thursday by reports that the ECB is exploring changes to ensure that enough debt is available to fulfill its quantitative-easing program.

One of the proposed steps is changing the allocation purchases away from the size of a nation's economy toward one more in line with outstanding debt, a person familiar with the discussions said.

QE Eligibility

That would benefit Spain and Italy, whose bond markets are relatively large compared with the size of their economies. The capital key requirement means there's a reliance on Germany's sovereign debt. More than half of the country's securities are ineligible for purchase under QE because they yield less than the ECB's deposit rate of minus 0.4 percent.

“If the ECB were to drop the capital key requirement, and instead buy proportionally according to relative bond-market size, it would buy more Italian” securities relative to the debt of France or Germany, said Marius Daheim, a senior rates strategist at SEB AB in Frankfurt. “This means Italian bonds should outperform bunds and other core or semi-core markets.”

Spain's 10-year bond yield fell two basis points, or 0.02 percentage point, to 1.14 percent as of 4:43 p.m. London time, having earlier touched a record 1.047 percent. The 1.95 percent security due in April 2026 climbed 0.185, or 1.85 euros per 1,000-euro ($1,115) face amount, to 107.45. This week's 49 basis-point decline in yields is the steepest since September 2012.

Spain's two-year note yield rose one basis point to minus 0.18 percent, having dropped earlier to a record minus 0.232 percent. Italy's 10-year bond yield fell four basis points to 1.22 percent, after dropping to 1.15 percent, the lowest since March 2015.

ECB Outlook

Investors are already speculating that the ECB will respond to the economic risks arising from Brexit by extending QE and reducing interest rates. Futures show a more than 50 percent chance of a rate cut by the ECB's September meeting. Bank of England Governor Mark Carney said Thursday that U.K. officials will probably have to loosen policy within months.

“The ECB will counter the headwinds that will ripple through European economies with an early statement to extend QE beyond March 2017 and keep the pace up, not only in buying government bonds but also corporate bonds as well,” Stephen Jones, chief investment officer at Edinburgh-based Kames Capital, which oversees about $77 billion, said in an interview this week.

Benchmark German 10-year bund yields were little changed at minus 0.13 percent. The yield difference, or spread, with similar-maturity Italian bonds narrowed earlier to 1.23 percentage points on Friday, the lowest in a month.

To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net. To contact the editors responsible for this story: David Goodman at dgoodman28@bloomberg.net, Keith Jenkins