Migration deal knocks German Bunds, lifts Italian bonds

LONDON - 29 June 2018: German bond yields pulled back from recent one-month lows on Friday after an agreement among European Union leaders to tackle migration eased fears of no accord and a potential collapse in the three-month-old German government.

In contrast, Italian 10-year government bond yields fell to a one-week low at 2.70 percent as the deal lifted sentiment towards the euro zone's riskier assets and allayed concerns that a new populist government in Italy was locked on a collision course with the EU.

Tense negotiations ended in an agreement to set up joint asylum processing sites and restrict migrant moves within the bloc, but EU leaders made clear that virtually all their pledges would be carried out by member states on a "voluntary basis".

"The outcome of the summit tells us something about the severity of the situation," said Jan von Gerich, chief analyst at Nordea in Helsinki.

"I'm not confident it will solve the underlying issues but there was a fear that the summit would fail and we could get a collapse of the German government, so that risk premium is being priced out," he said.

Germany's 10-year bond yield rose as much as 2.5 basis points to 0.34 percent, before drifting back down after inflation data from the currency bloc showed underlying price pressures remain subdued. It remained above one-month lows hit this week at around 0.30 percent.

German yields were set to end June virtually flat, after falling 22 bps in May as Italian political worries gripped the markets. German debt is seen as one of the world's safest assets.

While the migration deal lifted hopes that a row over migration policy in Germany's coalition government could now be resolved, it also boosted optimism about the new Italian anti-establishment government's ability to reach a compromise with EU partners.

"When the Italian coalition was formed, there was a significant building-in of a risk premium on a view that there were clear grounds for conflict between Italy and the EU," said MUFG's European head of global markets research Derek Halpenny.

"Going into this summit even yesterday, (German Chancellor Angela) Merkel was saying we wouldn't get a deal. It would now appear at least in part that Italy is willing to sit down at the table and compromise."

The euro firmed after the migration deal and was up 0.75 percent against the dollar, while European shares climbed 1 percent.

Data showed euro zone inflation rose to its highest rate in more than a year in June, above the European Central Bank's near 2 percent target.

But in a sign that underlying inflation is still muted, price growth excluding volatile food and energy costs slowed, capping a rise in bond yields.

Elsewhere, Greek 10-year bond yields touched their lowest in almost seven weeks at 4.004 percent, extending falls made after a recent debt relief agreement.

HSBC said on Friday it recommended buying five-year Greek government bonds after the country won a debt relief deal.