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French, Belgian bonds underperform as SNB drops euro/franc cap

* Belgian, French debt were seen main beneficiaries of SNB buying

* German yields hit record low as ECB QE seen offsetting SNB move

* Italy prepares to sell 30-year bond to tap yield hunt (Recasts with bond market moves after SNB scraps franc ceiling)

By Emelia Sithole-Matarise

LONDON, Jan 15 (Reuters) – French and Belgian bonds underperformed their euro zone peers on Thursday after the Swiss National Bank unexpectedly dropped its limit on the franc’s exchange rate against the euro, meaning it will buy less euro-denominated debt.

Yields on Swiss bonds out to seven years’ maturity dropped further into negative territory as the SNB also said it would charge banks for franc deposits for the first time since the 1970s.

French and Belgian bonds were considered the main targets for SNB investments in the euro zone as it intervened in the currency market to defend the cap and fend off deflation.

Their 10-year yields rose 3 basis points to 0.68 percent and 0.65 percent, respectively, bucking a fall in benchmark German Bunds to a record low of 0.402 percent. Analysts ruled out a selloff, saying the SNB move would be offset by the prospect of European Central Bank bond purchases – quantitative easing – that may come as soon as next week.

“The SNB was one of the big buyers (of euro zone bonds) … But this will be more than counterbalanced by upcoming QE by the ECB,” said Daniel Lenz, a strategist at DZ Bank.

BOND SALES

Belgian 10-year yield premiums over Bunds rose to 22 bps, off a seven-year low of 18 bps. The French yield gap over Bunds bounced off a five-year low of 22 bps.

Nordea strategists said the SNB move provided a trigger for investors to book profits in those markets after their out-performance Bunds.

“The upcoming ECB bond purchases, the issuance outlook and even the latest moves by the Swiss National Bank support the case for wider semi-core spreads,” they said in a note.

“There are clear country-by-country differences, while peripheral spreads do not look as vulnerable to an upward correction compared to semi-core spreads.”

German 10-year yields reversed an earlier rise to hit new lows, reflecting investor indecision about the SNB impact as there have been doubts over the amount of Bunds the SNB would buy and the impact it would have on Europe’s most liquid market.

Others said the SNB had also held out the possibility that it would still intervene in the currency market to defend the exchange rate, tempering the selloff in top-rated euro zone bonds.

On the euro zone’s periphery, Italian bond yields hovered near record lows on Thursday as Rome prepared to sell new 30-year bonds, taking advantage of investor demand for higher returns spurred by the prospect of fresh ECB stimulus measures.

Expectations of ECB QE have driven borrowing costs in the euro zone to historic lows. That has led countries to issue long-dated debt and ease funding pressure for the years ahead, especially countries on the region’s periphery.

Italy’s long-term bond, expected later in the day via a syndicate of banks, follows Portugal’s successful issue on Tuesday of its first 30-year bond since 2006 and only its second ever.

Italian 10-year yields were 2 basis points lower at 1.72 percent, just above a record-low 1.71 percent reached on Wednesday. The yield on the old 30-year bond was 1.5 bps lower at 3.186 percent.

(Additional reporting by Marius Zaharia)

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