Spanish Notes Rise After Auction as Italian Two-Year Yield Drops Below 2%

Spanish two-year notes gained for an 11th day amid speculation banks used the proceeds of yesterday’s European Central Bank cash offering to buy the nation’s securities at an auction today.

The yield on Italy’s two-year notes dropped below 2 percent for the first time since October 2010 as European Union finance ministers gathered in Brussels to discuss measures to combat the region’s debt crisis. French bonds also advanced after the ECB lent banks 529.5 billion euros ($705.9 billion) under its longer-term refinancing operation. German bunds fell as signs of global growth sapped demand for safer assets.

“The Spanish auction seems good from a volume perspective,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “The market is obviously fairly happy with the uptake from the LTRO and what that means in terms of supporting Spanish and Italian bonds.”

Spain’s two-year yield declined 13 basis points, or 0.13 percentage point, to 2.19 percent at 5 p.m. London time after dropping to 2.15 percent, the least since November 2010. The 3.4 percent note due April 2014 gained 0.275, or 2.75 euros per 1,000-euro face amount, to 102.515. The 11-day gain is the longest since November 2008.

Italy’s two-year yield fell 38 basis points to 1.76 percent after reaching 1.68 percent, the least since October 2010.

Money ‘Channeling’

Spanish securities have returned 3 percent this year through yesterday, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian debt gained 11 percent, while German bonds were little changed, the indexes show.

“We suspect that a lot of Italian and Spanish banks are channeling a lot of that money into the sovereign debt,” said Piet Lammens, head of research at KBC Bank NV in Brussels, referring to the ECB’s operation. “We know that with the money the Italian banks got at the end of December they upped their portfolio of bonds and we think they will continue to do this.”

The ECB awarded 529.5 billion euros in three-year loans to 800 European banks yesterday, after supplying 489 billion euros to 523 financial institutions on Dec. 21. Under the operation, banks can borrow at the average of the ECB’s key interest rate, currently at a record-low 1 percent, and use the funds to buy higher-yielding assets such as Italian and Spanish debt.

Debt Sales

Spain and France sold a combined 12.5 billion euros of bonds as ECB loans to banks helped spur demand, pushing borrowing costs lower.

The Spanish auction met its maximum target, with 4.5 billion euros of bonds allotted. The nation sold 1.9 billion euros of benchmark three-year bonds maturing in July 2015 to yield 2.617 percent, down from 3.332 percent when the security was last auctioned Feb. 16. France issued 7.99 billion euros of debt, at the top end of the range targeted by the treasury.

French bonds rose for a third day, with the 10-year yield dropping 11 basis points to 2.77 percent. The extra yield investors demand to hold the securities instead of similar- maturity bunds shrank 15 basis points to 91 basis points. The spread has narrowed from a euro-era record of 204 basis points on Nov. 17.

Germany’s bunds dropped as a U.S. report showed weekly jobless claims declined to a four-year low, and Chinese data showed manufacturing growth accelerated, sapping demand for safer assets.

The inflation rate in the 17-nation euro area climbed to 2.7 percent last month from 2.6 percent in January, the European Union’s statistics office said today.

Germany’s 10-year yield increased five basis points to 1.87 percent after rising two basis points yesterday.

Highest Volatility

Volatility in Greek debt was the highest in euro-area markets today, according to measures of 10-year bonds, two- and 10-year yield spreads and credit-default swaps.

The price of the nation’s 10-year bonds slumped to a record on concern it will use collective action clauses to enforce losses on bondholders.

The price of the 5.9 percent bond maturing in October 2022 dropped to 19.14 cents on the euro even after the International Swaps & Derivatives Association ruled that insurance against bondholder losses doesn’t need to be paid as yet.

“What the market is focused on now is whether the activation of the collective action clauses will be a credit event,” said Mohit Kumar, the head of European fixed-income strategy at Deutsche Bank AG in London. “There is uncertainty surrounding that and the ISDA can only rule on that after the CACs are triggered.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Emma Charlton in London at echarlton1@bloomberg.net

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

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