Spanish bond yields up as PM Sanchez calls snap election

Spanish government bond yields rose on Friday as the spectre of fresh elections loomed, while Italian bonds took a beating as concerns about the country's ratings outlook moved into focus ahead of a Fitch Ratings review a week away.

Spanish Prime Minister Pedro Sanchez on Friday called a snap election for April 28, potentially spelling months of uncertainty in the euro zone's fourth-largest economy, where the political landscape is increasingly fragmented.

Spanish 10-year bond yields held 2 basis points higher at 1.26 percent after the announcement, while its spread over top-rated Germany was the highest in about a month.

Morgan Stanley analysts said that although the chances of fiscal slippage in Spain looked higher than previously, the economic outlook appeared solid and they remained bullish on the country's bonds in the medium term.

"The macro fundamentals remain robust in absolute terms and relative to the semi-core - a view which we don't think is yet fully priced in by the market," wrote rates strategist Robert Brown.

He said a dovish stance from the European Central Bank would provide broad support for peripheral debt this year as investors reach for yield and the ECB seeks to contain volatility.

Rabobank rates strategist Lyn Graham-Taylor said that he expected some spread widening as the election date approaches, particularly in light of impending European elections. "If you want to short Italy or Spain, it is very expensive from a carry perspective, so people want to put it off for as long as possible," he said.

He added that Spain's debt metrics will likely suffer more than Italy in the event of a broader economic downturn because despite having higher growth, its government has not been able to reduce its debt.

"The elections could be a source of short-term volatility but I can't see how it will change the bigger picture," said Jan von Gerich, rates strategist at Nordea.

Italian

bonds

were

the bloc's biggest underperformer, with 10-year yields 6.5 basis points higher at 2.87 percent.

Analysts put this down to a combination of the upcoming ratings review by Fitch, as well as weak data out of Europe that is contributing to broader riskoff sentiment.

A key gauge of the market's long-term expectations for inflation in the euro zone fell on Friday to its lowest level in more than two years, extending its downward push as weak data exacerbates concerns about economic growth and inflation.

The five- year, five-year breakeven forward, a key market gauge tracked closely by the European Central Bank, fell to as low as 1.4177 percent. The ECB targets inflation of just below 2 percent.

Core euro zone bond yields fell sharply after weak U.S. retail sales data added to the case for a lower-for-longer rates outlook and held close to these levels on Friday.

Germany's benchmark 10year government bond yield was last at 0.105 percent. Other core 10-year yields were largely flat on the day.