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Spanish, Italian Government Bonds Slide as Splits Emerge Before EU Meeting

Spanish and Italian bonds fell on concern divisions among European officials will hamper efforts by finance ministers meeting in Brussels to stem the region’s sovereign-debt crisis.

The declines drove the extra yield investors demand to hold the bonds of high-deficit nations instead of benchmark German securities higher for the first time in four days. Irish and Portuguese bonds outperformed their peers as traders said central banks bought the nations' debt today. Ministers will discuss today details of a permanent mechanism to support economies struggling to raise funding, which is intended to replace the European Financial Stability Facility in 2013.

“The uncertainty over the euro mechanism is being priced into the market and that’s driving the yield movements,” said Michael Kruse, a fixed-income analyst in Zurich at Credit Suisse Group AG. “The uncertainty is not great for the markets.”

The 10-year Spanish bond yield climbed 12 basis points to 5.20 percent as of 4:11 p.m. in London. The 4.85 percent security due in October 2020 fell 0.87, or 8.7 euros per 1,000- euro ($1,329) face amount, to 97.33. The extra yield, or spread, with bunds increased 10 basis points to 229 basis points, or 2.29 percentage points.

Italian 10-year yields rose five basis points to 4.5 percent, and the yield on similar-maturity Belgian debt advanced five basis points to 3.96 percent. Credit-default swaps on Italy jumped 8.5 basis points to 217.5, while those on Spain increased 20 basis points to 317, according to CMA prices. Contracts on Ireland were 12.5 basis points higher at 555 and those for Portugal were up 15.5 basis points to 443.5.

The euro slumped 0.9 percent to $1.3292, snapping a three- day gain.

EU Bond Buying

Government bonds from the euro area’s so-called peripheral nations surged last week amid speculation the European Central Bank bought the assets to cool the region’s debt crisis. ECB policy makers also extended extraordinary stimulus measures to stem the fallout in financial markets following Ireland’s Nov. 28 bailout agreement.

“The rally that we saw last week was a bit excessive, probably boosted by purchases of Portuguese and Irish bonds,” said Ioannis Sokos, an interest-rate strategist at BNP Paribas SA in London. “I expect volatility and uncertainty to remain.”

ECB Governing Council member and head of Cyprus’ central bank Athanasios Orphanides said today the ECB is “actively” operating in the government bond market and the central bank will act in the markets as necessary.

Irish, Portuguese

The ECB settled 1.965 billion euros of purchases last week, the most in 22 weeks, it said today. Most transactions between Dec. 1 and Dec. 3 haven’t yet settled, the central bank said.

The ECB bought Irish and Portuguese government bonds today, according to three traders with knowledge of the transactions, who declined to be identified because the deals are private. A spokeswoman at the ECB in Frankfurt declined to comment.

Irish 10-year yields were little changed at 8.37 percent, while similar-maturity Portuguese debt yields added one basis point to 6.09 percent.

“The fact that Portugal and Ireland are outperforming seems to indicate that the European Central Bank is active in the markets,” said Michael Leister, a fixed-income analyst at WestLB AG, said by phone from London.

The purchases are providing a “false sense of stability” that may lead to a larger crisis at a later date, according to Royal Bank of Scotland Group Plc.

‘Lack of Solidarity’

“The tension in spreads will not stop,” rates strategists Harvinder Sian, Simon Peck and Biagio Lapolla wrote in a research report on Dec. 3. “The real market moves are now driven by higher default risk on the lack of solidarity from core Europe and potentially lower recovery rates from the European Stability Mechanism’s preferred-creditor status.”

Standard & Poor’s said last week it may downgrade Greece because the ESM, which will succeed the financial stability facility, could assign a preferred-creditor status to future lending by euro-area nations, potentially reducing investors’ ability to get paid in the event of default.

Countries including Greece are “in denial” in saying they’ll be able to repay their full borrowing bills, Kenneth Rogoff, a Harvard University professor and former International Monetary Fund chief economist, told Bloomberg Television today. “We’d be very lucky to avoid restructuring.”

The IMF said the ECB should buy more bonds and will ask the European Union to enlarge the bloc’s rescue package, Reuters reported yesterday, citing a report from the IMF that it obtained. Belgian Finance Minister Didier Reynders said two days ago that the region’s 750 billion-euro bailout fund could be increased to stem contagion from the sovereign debt crisis, breaking ranks with German Chancellor Angela Merkel and French President Nicolas Sarkozy.

Merkel Opposition

ECB council member Guy Quaden told reporters at a briefing in Brussels today that he also favors increasing the size of the bailout fund.

Merkel told reporters in Berlin today she opposed adding to the rescue fund. She also rejected a suggestion by Jean-Claude Juncker, prime minister of Luxembourg and leader of the group of euro-area finance ministers, and Giulio Tremonti, finance minister of Italy, that European nations should issue joint bonds as a response to the crisis. Merkel also said Germany “will always do everything” it can to ensure a strong and stable euro.

Spanish Economy Minister Elena Salgado said proposed joint eurobond issuance is a “possibility to be explored.”

LCH Clearnet Ltd. said today it will reduce the extra deposit it charges clients on Irish government bond trades to 30 percent from 45 percent.

The Irish government will lay out details tomorrow of 6 billion-euros of spending cuts and tax increases. Prime Minister Brian Cowen’s Fianna Fail party has a minority of seats in parliament and may need the backing of independents who have yet to declare support for the budget.

The yield on the 10-year bund declined one basis point to 2.85 percent.

To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net

To contact the editor responsible for this story: Daniel Tilles at dtilles@bloomberg.net

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