Will Spain’s and Italy’s bond spreads continue to fall?

The yield spreads of Spanish and Italian government bonds over German Bunds began to fall sharply following the announcement of the ECB’s Outright Monetary Transactions programme in the summer of 2012 and have since continued to narrow as the economic outlook has brightened. However, we think further significant falls in spreads are unlikely given that redenomination risks appear to have been eliminated and there is only a slim chance of a big improvement in these countries’ credit ratings.