Irish bonds managed to escape the gloom engulfing peripheral countries yesterday after Standard & Poor's (S&P) said plans by German and French banks to roll over Greek debt were likely to be an "effective default".
While Irish 10-year bond yields rose initially when the S&P opinion emerged, they later recovered. Yields fell four basis points to 11.58pc, after climbing seven basis points to 11.67pc earlier.
The bond market will take some reasassurance from the latest exchequer returns, which show spending and tax revenues broadly on target.
However, solving the Greek problem has become more difficult with ratings agencies sceptical that a debt rollover deal is anything but a default.
The German and French banks are considering taking 30-year bonds as part of the rollover plan, but S&P said such a deal meant "less value" being offered to bondholders and the whole transaction appeared to be "distressed", meaning it constituted a default in its current form.
The agency left the door open that it might change its position if it got "mitigating" information.
While Irish bonds held firm and yields on two-year debt fell, Spanish and Italian bonds fell, driving up their yields.
Greek 10-year government bonds fell, pushing the yield up 11 basis points to 16.45pc
"The S&P news is weighing on sentiment," said Michael Leister, a fixed-income analyst at WestLB in London.
"The treatment by ratings agencies of any Greek bailout or rollover plan is crucial given the secondary effects if they were to deem it a credit event.''
There was also speculation that the ECB would continue to accept Greek government debt as collateral, even if S&P deemed the nation to be in "selective default" if a bond rollover deal was struck, maintaining a lifeline to the nation's banks.
The ECB declined to comment on the S&P release.
"It is difficult to think of the ECB precipitating the kind of crisis for Greece in which it wouldn't take their bonds as collateral," said Luca Jellinek, head of European interest-rate strategy at Credit Agricole.
"To the extent the Greek government bonds are okay, that would indicate the market thinks a way will be found to get the ratings agencies to not consider the Greek paper defaulted or that the ECB will say that they will accept this paper."
German notes may fall this week as the European Central Bank raises borrowing costs. The ECB will lift its refinancing rate to 1.5pc from 1.25pc on July 7, according to most economists.