Fri Apr 25, 2014 6:40am EDT
* Italy yields hover above record lows
* Lower-rated bonds, stocks struggle
* Market awaits Spain rating announcement (Adds fresh quotes, updates prices)
By John Geddie
LONDON, April 25 (Reuters) - Italian bond yields hovered just above record lows on Friday, underpinned by a ratings outlook lift from Fitch as concerns about Ukraine prompted investors to pull out of lower-rated paper.
Viewed as one of the riskiest investments at the height of the euro zone crisis, bonds issued by Rome have become an increasingly popular bet as the country's economy has started to recover and returns on core euro zone debt continue to flirt with historic lows.
Italian 10-year yields dipped 1 basis point to 3.11 percent in early trading, just above the record low of 3.07 percent hit last week.
"It is a reminder that the world has changed its mind about periphery," said Luca Jellinek, European head of fixed income at Credit Agricole.
Spanish debt - which tends to track its Italian equivalent - also held its own, as did euro zone benchmark German Bunds.
But lower-rated bonds, global stocks and currencies struggled after Ukrainian forces killed up to five pro-Russia separatists and Russia conducted military drills near the border, raising fears it was gearing up to invade.
VAST IMPROVEMENT
Emerging from recession at the end of last year, Italy has benefited from a vast improvement in financing conditions. Fitch pointed out that its average issuing yield in the first quarter or the year was 1.6 percent, a historic low.
Fitch, which already rates Italy one notch above the other two main agencies Standard and Poor's and Moody's, affirmed the country at BBB+, raising its outlook to stable from negative.
Italy sold 5 billion euros at auction on Thursday, hitting nearly 40 percent of its annual funding target.
"Italian bonds are not traded as a credit any more, but more on the (Central Bank) rates outlook like German Bunds," said one government bond trader.
Bunds rallied 3 bps to hit 1.51 percent, while yields on Greek bonds - the highest in the bloc - rose 14 bps to 6.30 percent.
With official interest rates already at historic lows, the European Central Bank has raised the prospect of loosening its monetary policy further, encouraging investors to buy peripheral debt.
Some think that yield levels are becoming too rich.
"We have been, and remain overweight in the euro periphery, though our sense is that we have now witnessed the majority of the rally," said Mark Dowding, a senior portfolio manager at BlueBay, one of Europe's largest bond funds.
But others see little resistance to more declines, especially with the ECB raising the possibility of a programme of asset purchases known as quantitative easing.
"We have been, and remain, in a clear tightening trend, and a lot of that is based on the assumption that any quantitative easing is favourable," said Jellinek at Credit Agricole.
Spanish yields dipped 1 bp to a day's low of 3.07 percent, as markets also awaited a scheduled ratings update from Fitch in Madrid.
Fitch has tended to announce ratings actions before the markets open, but also has the option of waiting until after the close.
Spain, like Italy, has enjoyed much improved market access in 2014. It has completed more than 40 percent of its funding programme already, paying record low costs to borrow 5.6 billion euros at auction on Thursday.
In further evidence of ratings agencies taking a more positive view on the periphery on Friday, both Fitch and Standard and Poor's lifted Cyprus less than a year after the country was bailed out.
S&P raised Cyprus' rating to B from B-, with a positive outlook. Fitch affirmed Cyprus' B- rating, raising its outlook to stable from negative. (Editing by Sonya Hepinstall, John Stonestreet)
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