Fading Populism Boosts European Bonds -- Update

French and Italian bonds rose in value and the British pound continued its fall on Monday, with investors taking very different views of the politics currently affecting three of Europe's largest economies.

Weekend ballots in France and Italy showed signs that the popularity of the antiestablishment parties that had spooked investors earlier this year continues to wane. But the pound has been falling since the U.K.'s ruling Conservative Party failed to secure a Parliamentary majority in last Thursday's election, spurring investor concern that this will make Brexit negotiations even harder for Britain.

The yield on French 10-year government bonds fell around 0.05 percentage point to 0.593%, according to Tradeweb, its lowest level since November. That came after French President Emmanuel Macron's La République en Marche party won the first round of parliamentary elections on Sunday, putting the upstart centrist party on course to secure a sweeping majority. Yields fall as prices rise.

The yield on Italy's 10-year government bond fell around 0.09 percentage point to 1.996%, its lowest level since January, after no candidates from the antiestablishment 5 Star Movement made it through to the runoff vote for any of the main cities contested in Italian municipal elections.

Sterling was down 0.61% against the dollar and euro, on the heels of the currency's 1.7% decline against the U.S. currency Friday. The yield on 10-year U.K. government bonds was around 0.03 percentage point lower at 0.984%, meanwhile, as investors sought havens amid the continuing political uncertainty.

"In the near term, the risk of populism across Europe is in retreat," said Nicola Mai, global sovereign credit analyst at Pacific Investment Management Co. "Both on the macro side, where the data are really strong in Europe, and on the politics side, things have been quite encouraging for markets," he said.

Investors views on the eurozone have become increasingly bullish as the U.K. economy, typically Europe's second biggest after Germany, has slowed.

The eurozone economy grew at its quarterly fastest rate in the first three months of 2017 since the first quarter of 2015. Signs that antiestablishment, euroskeptic parties are losing momentum have also cheered investors. Britain's economic growth was revised lower to 0.2% in the first quarter of the year, according to figures released last month.

Investors dumped French bonds earlier this year on concerns that far-right candidate Marine Le Pen could clinch the French presidency. Ms. Le Pen favored pulling France out of the euro -- a move many have feared would presage a messy breakup of the currency bloc.

But Mr. Macron won a convincing victory in May and Sunday's vote in France has put Mr. Macron's party and its centrist ally, MoDem, on course to win a majority of as much as 455 seats in the 577-seat National Assembly in the second-round vote a week from now, according to polling firm Ipsos Sopra-Steria. That would strengthen Mr. Macron's hand in his efforts to loosen France's rigid labor laws.

"Political risk in France has disappeared and it's good for structural reforms over the long term," said Thomas Page-Lecuyer, a strategist at CPR Asset Management.

In Italy, the euroskeptic 5 Star Movement failed to reach the second round of voting for any of the major cities in local elections -- a contrast with its victories in Turin and Rome last year.

Italian government bonds had already been boosted last week after the risk of a snap general election receded when Italy's largest political parties failed to agree on a new electoral law. The European Central Bank on Thursday reaffirmed its commitment to keep its massive bond-buying program in place, which has supported Italian debt in recent years, lending further support to the market.

The 5 Star Movement's "impetus seems to have lost some momentum," Barclay's economist Fabio Fois wrote in a note to clients.

Still, Mr. Fois said he expected the 5 Star Movement to keep polling neck and neck with the ruling center-left Democratic Party at the national level. Meanwhile, the risk of no party securing enough seats in parliament to win an outright majority remains high ahead of the country's next general elections, he said.

Pimco's Mr. Mai said the risk of populism in Europe hasn't gone away.

"While populism might be on the decline while the macro [economy] improves in Europe, at the next crisis there is going to be significant risk again of populism rising," he said.

Meanwhile, investors are giving the U.K. a bit of time before making big investment decisions. The key is discerning what Thursday's election means for Britain's negotiations with Brussels. Some investors say reduced Conservative Party influence could lead to a softer Brexit, which could be good for the economy, but others argue that the increased uncertainty will make the divorce even more tortuous and unpredictable.

In the meantime, though, the direction has been lower for the pound -- the main barometer for investor sentiment toward the U.K.

"The bit of opacity is around what happens in the negotiations with the EU," said Stephen Macklow-Smith, a portfolio manager at J.P. Morgan Asset Management.

Jon Sindreu contributed to this article.

Write to Christopher Whittall at christopher.whittall@wsj.com

(END) Dow Jones Newswires

June 12, 2017 11:55 ET (15:55 GMT)