UPDATE 1-Southern European bond yields touch record lows

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts with move in southern European bonds, adds chart)

LONDON, Dec 15 (Reuters) – Southern Europe’s borrowing costs hit new record lows on Tuesday as concern about rising COVID-19 cases in major economies offset the promise of a return to normality due to a vaccine and cautious optimism about Brexit trade talks.

Renewed uncertainty about the economic outlook underpinned bond markets across the euro area just days after the European Central Bank unleashed fresh stimulus to shore up the economy from the coronavirus shock.

Peripheral bond markets, which in recent months have tended to benefit when sentiment towards the recovery improves but also when uncertainty fuels expectations for ECB stimulus, continued to outperform.

Ten-year bond yields in Italy, Spain, Portugal and Greece all fell to new record lows.

“The market remains wary of the light at the end of the tunnel,” said Commerzbank rates strategist Rainer Guntermann.

“While Bunds remain torn between vaccine hopes and lockdown concerns, spreads continue to tighten as the ECB ‘preserves favourable funding conditions’,” he added, referring to hefty ECB stimulus that has pinned down borrowing costs.

Italy’s 10-year bond yield dipped to as low as 0.492% ; Spanish and Portuguese long-dated yields fell to fresh lows at -0.006% and -0.044% respectively.

Greek yields were down 3.5 basis points at a new record low at 0.57%.

In so-called core bond markets, Germany’s 10-year bond yield was steady, having dipped to -0.627% — near recent one-month lows of around -0.64%.

Italy will need to impose new restrictions during the holiday season to rein in contagion and avoid a third, devastating wave of the coronavirus, the prime minister said in an interview published on Tuesday.

Germany, Europe’s biggest economy, is unlikely to lift its lockdown early next year, a top aide to Chancellor said on Monday. London, meanwhile, will move into England’s toughest tier of restrictions on Wednesday.

Antoine Bouvet, a senior rates strategist at ING, said the current backdrop was also favourable for a near-term tightening in the gap between U.S. and European bond yields.

The gap between 10-year U.S. and German bond yields is at around 152 bps, not far off its widest levels since March.

“Barring an imminent trade deal, Brexit optimism should slowly deflate, leading to lower rates,” he said.

“Recent lockdown announcements suggest that gloom will persist on both sides of the Atlantic, and drive a temporary re-tightening of the U.S. and euro rates differential.”

Elsewhere, a German finance ministry document showed the euro zone’s benchmark bond issuer earned more than 7 billion euros ($8.51 billion) from issuing new bonds this year as negative yields pushed down overall debt servicing costs to record lows.

Reporting by Dhara Ranasinghe; Editing by Pravin Char and Ed Osmond

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