Core euro zone government bond yields fall on weak German data
* Euro zone stress tests bring relief to euro zone bond market * Italian bonds underperform Spanish ones but yields still falling * German yields reverse rise after weak German Ifo data (Updates prices, adds quotes) By Marius Zaharia LONDON, Oct 27 (Reuters) - Peripheral euro zone government bond yields rose on Monday as a weak German sentiment survey prompted a shift to safer core debt, overshadowing relief that there were no unpleasant surprises from bank stress tests.
The results of the European Central Bank's Asset Quality Review, released on Sunday, showed that no major bank was in trouble, and those that failed had a relatively small capital hole to fill.
Italy's performance, however, was poor with nine banks failing to meet the ECB's criteria, whereas Spain's banks got a clean bill of health.
That helped send Italy's 10-year bond yield up to more than 40 basis points over Spanish equivalents on Monday, the widest since February 2012.
Economic data that reinforced the view of a weak euro zone economy pushed German 10-year bond yields lower after an early rise, and saw investors shift out of peripheral bonds.
A survey by the Munich-based Ifo think tank showed German business sentiment deteriorating for a sixth month running to its lowest in almost two years.
"You saw a bit of a relief rally this morning after the tests came in on consensus, and then we had the German Ifo so the attention pretty swiftly turned back to that," said Rabobank fixed income strategist Lyn Graham-Taylor.
"Is this (stress tests) going to see banks suddenly start lending to everyone, increasing their balance sheets? No, and the Ifo has built on that looking at the demand side." Ten-year German Bund yields, which set the standard for euro zone borrowing costs, fell 2 basis points to 0.87 percent.
STRESS TESTS Only 25 of 130 euro zone banks tested failed the European Central Bank's assessment at the end of last year, with a total 25 billion euro capital shortfall. Investors saw this as manageable and reassuring.
Of the banks that failed, a dozen had already raised 15 billion euros to make repairs. The main problems were in Italy, Cyprus and Greece.
Spanish 10-year yields fell 4 basis points to 2.14 percent, while Italian yields rose 3 basis points to 2.55 percent.
"The fundamentals are clearly in favour of Spain relative to Italy, whether its growth, fiscal, banking or indeed political," said RIA Capital Markets bond strategist Nick Stamenkovic.
"The likelihood is that Spain will continue to outperform Italy in the near term." Traders said part of Italy's underperformance versus Spain could be explained by plans to sell 3.5 billion euros of zero-coupon and inflation-linked bonds on Tuesday, as well as medium- and long-term debt on Thursday.
(Additional reporting by Michael Urquhart; Editing by Susan Fenton)
