REFILE-UPDATE 2-Euro zone government bonds steady as little surprise from European Council

(Refiles to fix spelling error in headline)

* Euro zone periphery govt bond yields

By Olga Cotaga

LONDON, June 19 (Reuters) – Euro zone government bond yields were little changed on Friday, reflecting no surprises from a European Council meeting focused on a proposed 750 billion euro coronavirus recovery fund, with divisions on how it should be split between grants and loans.

German 10-year yields were down one basis point to -0.42% in late trade, while Italian 10-year yields were down 2 basis points at 1.32%.

European Central Bank head Christine Lagarde urged the bloc’s leaders to quickly agree the package or risk a change in sentiment on markets, which are expecting a deal soon.

Austrian Chancellor Sebastian Kurz said he hopes the EU will agree on the fund as soon as July, but first member states need to discuss which countries should benefit most and what the money will be used for.

Prospects of the worst-hit states receiving 500 billion euros in grants has boosted southern European and particularly Italian debt in recent weeks.

Mizuho analysts said that unless talks break down completely, they expect the risk premium Italy pays for 10-year debt on top of Germany to fall to around 160 basis points from a current 173 bps reading.

“There’s further potential to rally beyond there on positive news,” they said, adding that the ECB’s upsized emergency purchases are likely to limit losses on Italian bonds.

There was also market focus on the record take-up of the European Central Bank’s new round of cheap loans which is expected to support short-dated borrowing rates.

Three-month Euribor fell another 2 basis points to -0.407% on Friday, compared to a -0.16% high reached in April.

“Large TLTRO take-up, especially in the periphery, will cement expectations of lower Euribor fixings, especially for longer tenors,” ING analysts told clients.

Banks often take up cheap loans and invest the money in “carry trades”, buying short-dated government bonds, particularly in southern Europe, where yields are higher, so a high take-up is also expected to lower the risk premium they pay.

“Reports from large peripheral banks that they drew their max TLTRO allowance yesterday will be key in reducing perceived systemic risks in our view. This adds to the case for tighter sovereign spreads,” ING analysts said. ($1 = 0.8921 euros)

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