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GRAPHIC-Government/corporate bond gap shows extent of ECB QE bet
* Yield gulf shows ECB goverment bond-buying priced in
By John Geddie and Vikram Subhedar
LONDON, Nov 4 (Reuters) - Investor (Other OTC: IVSBF - news) expectations that the European Central Bank will resort to buying sovereign bonds to stave off deflation have steadily ratcheted up over the last year, according to analysts at UBS (NYSEArca: FBGX - news) .
They measured the implied probability of a full-blown quantitative easing programme using the difference in yield between bonds of the euro zone's largest peripheral economies and those issued by similarly rated companies.
The gap (NYSE: GPS - news) between an average of Spanish and Italian five-year yields and implied yields on Markit (NasdaqGS: MRKT - news) 's main index for firms with credit ratings at BBB is back at levels not seen since 2010.
Sovereign yields ballooned at the peak of the euro zone's debt crisis, with several countries forced to seek international bailouts, but have tumbled since ECB President Mario Draghi's 2012 pledge to do "whatever it takes" to save the euro.
At face value, therefore, a graphic of this spread shows a return to historically 'normal' conditions where investors assume governments are less likely to default than companies.
But credit ratings for the two sovereign borrowers have deteriorated markedly in recent years, with both slipping into the triple-B bracket -- the lowest investment-grade category -- as they were engulfed by the euro zone's debt crisis.
At the start of 2010, Italy carried single- and double-A ratings while Spain even had some top-notch triple-A ratings.
UBS analysts say the difference between sovereign and corporate bond yields now can only be explained by the prospect of the ECB directly buying government debt.
"We are again in a regime where sovereigns trade below corporates, but this time around the fundamentals are clearly not as robust on the sovereign side," said Thibault Colle, credit strategist at UBS.
"This tightening has happened without a commensurate improvement in fundamentals and that points to only one possible conclusion -- QE expectations have started to become more and more priced in."
Euro zone money market traders gave a median 50 percent chance of ECB sovereign debt purchases in a Reuters poll this week, up from 40 percent last month.
(Editing by Catherine Evans)
