EURO GOVT-Irish bonds steady; Bund ylds fail to break higher

* Irish bonds little changed on stress test reports

* Credit rating downgrade looming?

* Bunds yields hesitant to push higher

By Kirsten Donovan

LONDON, March 31 (Reuters) – Irish government bond yields
remained elevated on Thursday with expectations of a credit
rating downgrade offsetting signs of a radical restructuring of
the banking sector.

The Irish Independent newspaper reported that the Irish
government would announce the restructuring after the results of
bank stress tests are published later on Thursday. The paper
said they would show the four main banks need 20-25 billion
euros in additional capital. [ID:nWLA6824].

That figure was largely in line with markets’ expectations
and Irish bond yields edged lower in early trade, although the
3-10 year portion of the yield curve was still comfortably above
10 percent.

“Whatever happens today won’t be the end of the story,” said
ING rate strategist Padhraic Garvey.

“The real game changer has been the details of the European
Stability Mechanism (ESM) and Standard & Poor’s interpretation
of that which has been quite negative for the stressed periphery
and we expect to see an Irish downgrade in the next few days.”

Ratings agencies have warned that plans for the ESM —
Europe’s permanent rescue fund for troubled states — raise the
chances of a default in the near-term by countries like Greece
and Ireland because they are likely to lead to private sector
creditors getting back less than the full amount owed.

The Irish government has set aside about 35 billion euros
for its debt-ridden banks, and the figure reported by the Irish
independent was well below that [ID:nLDE72T20R]. But the tests
will need to be rigorous enough to convince agencies and
investors that there are not substantial more losses to come.

S&P cut Portugal and Greece earlier this week, citing risks
around the new bailout fund. That risk also applies to Ireland
which S&P currently rates at A-, three notches above its BBB-
rating on Portugal.

Moody’s and Fitch currently rate Ireland one notch below S&P
at Baa1/BBB+.

“There is definitely a risk for a multi-notch downgrade of
Ireland,” said ING’s Garvey.

“The entire stressed periphery is more stressed now than it
was a few months back and we expect that to intensify.”

BUNDS HESITATE

June Bund futures (FGBLc1: Quote, Profile, Research) were 12 ticks higher at 121.55.
Two-year bond yields (DE2YT=TWEB: Quote, Profile, Research) were flat at 1.765 percent
with 10-year yields (DE10YT=TWEB: Quote, Profile, Research) down 2 bps at 3.32 percent.

Ten-year yields have risen almost 40 basis points in the
first quarter but have struggled to break above 3.34 percent,
the top of the range seen over the last two months.

Traders said investors were largely sidelined ahead of
Friday’s U.S. employment report and may struggle to put on
longer-term positions even after it.

“The market still isn’t sure which way it wants to go, if
the data starts coming off and it looks like interest rate hike
expectations have been overdone then yields are not necessarily
going higher,” said one trader.

If yields do break the 3.34 percent level, then they could
quickly target the 3.37 percent level, the 50 percent
retracement of the fall in yields since mid-2008, with the 61.8
percent retracement coming in at 3.676 percent.

Euro zone flash inflation data released at 0900 GMT will
reinforce expectations for an April interest rate rise if it
comes in line with forecasts for a 2.3 percent rise.

For now, the market seems willing to draw a line in the sand
of the euro zone debt crisis with Portuguese yields and the
10-year yield spread over Bunds at euro lifetime highs, but
Spanish and Italian spreads trending tighter.

“After yesterday’s solid Italian auctions we see no reason
for the spread tightening trend to run out in coming days,” said
Commerzbank strategist Christoph Rieger.

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Graphic on Peripheral bond yield spreads
http://link.reuters.com/dyt78r

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Traders expect Portuguese bond yields to converge towards
those of their Irish counterparts with a request from Lisbon for
financial aid seen as inevitable before it faces almost 7
billion euros of coupon and redemption payments in June.
The spread between Irish and Portuguese 10-year bond yields
has narrowed to 182 bps from around 235 bps a week ago and 250
bps at the end of last year, but that still leaves room for
Portuguese yields to rise by close to 2 percentage points, all
other things equal.

— Graphics by Kirsten Donovan

EURO GOVT-Irish bonds steady; Bund ylds fail to break higher