EURO GOVT-Irish-led relief rally in fringe EMU;Portugal eyed

* Ireland leads fringe EMU bonds higher

* Investors covering short positions before ECB

* Rally seen temporary for Portugal as borrowing costs soar

* Portugal sells T-bills, but at very high costs

By Emelia Sithole-Matarise

LONDON, April 6 (Reuters) – Portuguese government debt
yields snapped an 11-day surge on Wednesday, led by a slide in
Irish yields as some investors covered short positions before a
European Central Bank rate decision on Thursday.

Traders and analysts said the fall in Portuguese yields was
likely to be shortlived with investors increasingly convinced
Lisbon will have to seek a bailout as the caretaker government’s
borrowing costs soared at an auction of short-term funds.

Irish 10-year yields fell by as much as half a percentage
point to 9.399 percent, extending this week’s falls as concerns
about its ailing banks abated after stress tests, helping other
peripheral euro zone bonds to outperform German benchmarks.

“There’s quite a lot of shorts built up in the market over
the course of the last year or so… It’s too early to say
whether it’s a shift in sentiment or just a pause,” a trader
said. “There literally were no buyers in the market for the last
couple of months so all it takes is for a few buyers to come in
and people get squeezed up very quickly.”

Some traders said investors were wary of holding short
positions going into the ECB meeting on Thursday where the bank
is widely expected to raise interest rates for the first time
since October 2008. Uncertainty remains on how aggressively it
will tighten monetary policy for the rest of the year.

Following in the downdraft of Irish bond yields, Portuguese
10-year yields fell 24 bps to 8.76 percent, slipping for the
first time since March 22, when the government in Lisbon
collapsed after parliament rejected further austerity measures.

With its bond yields at euro-era highs, some investors took
the opportunity to snap up Portugal’s high-yielding short-term
paper, but funding at those levels was seen as unsustainable and
only a temporary option. [ID:nLDE7350HL]

At best, it could potentially buy Portugal time until after
a June 5 election, when a new government is widely seen as
facing the immediate task of negotiating a bailout.

“The interest was quite attractive for investors, because in
the end there is the assumption that Portugal will not be forced
to restructure until 2013 and any financing problem will be
covered by the EFSF,” said ING strategist Alessandro Giansanti.

“It is not risk-free. Portugal is reducing the length of its
debt, while it can have the same rate for the loans from the
EFSF. It is getting quite dangerous for the country.”

Portugal’s 10-year bond yield (PT10YT=TWEB: Quote, Profile, Research) was last down 24
bps at 8.76 percent, off a peak of 9.096 percent reached
earlier, while its two-year yield was last 23 bps lower at 9.15
percent.

A 5.9-6.04 percent yield spread for the 12-month T-bill
auction, against a 4.1-4.4 percent spread last month, made it
clear that Portugual’s rates had not peaked yet, said Lena
Komileva, head of G10 strategy at Brown Brothers Harriman.

It also meant “the government would have to come into the
markets with smaller amounts as the domestic banks’ capacity to
tolerate additional risk diminishes,” she said.

ECB STANCE FAVOURS BUNDS LONG-TERM

The rally in peripheral euro zone bond prices pushed Bunds
lower, with the Bund future (FGBLc1: Quote, Profile, Research) settling 31 ticks down on
the day at 120.62.

The benchmark 10-year Bund yield (DE10YT=TWEB: Quote, Profile, Research) was up 3.3
bps at 3.430 percent, while the two-year Schatz yield
(DE2YT=TWEB: Quote, Profile, Research) was 0.8 bps higher at 1.849 percent.

The ECB meeting may lead to some short-term volatility but
Bund yields are expected to maintain their longer-term rising
trend. Investors are looking for relative value plays among
triple-A rated paper.

Russell Silberston, head of global interest rates at
Investec Asset Management, which manages fixed income assets
worth $29 billion, said he was waiting for the ECB meeting
before betting on Bunds against UK gilts and U.S. Treasuries.

“If … policy is normalising, the view that we really want
to take is that Bunds are going to outperform Treasuries and the
UK (gilts) because the ECB have been pre-emptive, and by doing
that there’s less problems going further.”
(Additional reporting by Marius Zaharia; Editing by Hugh
Lawson)

EURO GOVT-Irish-led relief rally in fringe EMU;Portugal eyed