Peripheral European Bond Yields Narrow As Merkel Forms 'grand Coalition' With SPD

The announcement comes after months of talks between the two parties, and signals an end to the longest period without a government since World War II, after Merkel failed to secure an overall majority in the September elections.

Merkel, who will begin her fourth term as German Chancellor, has conceded the finance and foreign ministries roles to the SPD, who have previously called for a "United States of Europe".

On the news, Italian, Spanish and Portuguese 10-year government bond yields were 5-7 basis points lower on the day, and spreads over benchmark German bunds tightened, according to Reuters, as investors became more positive about the SPD's pro-European stance.

Elsewhere, the euro was up 0.12% to £0.888 and down 0.2% against the dollar to $1.235, while Germany's DAX equity index rose 0.7% to 12,480 points.

Peter Chatwell, head of rates strategy at Mizuho, told Reuters: "This news is positive for spreads and for anyone that wants a well-constructed and viable Europe.

"Investors in the higher-yielding sovereigns in the euro area want that to happen so that we don't go through another crisis.

"Having a distinctly European flavour to a German grand coalition is very helpful in that respect."

The 'grand coalition' still has to be ratified by the SPD's 464,000 party members before Merkel can take office.

Carsten Nickel, managing director for Europe at Teneo Intelligence, told CNBC: "Let us make no mistake, the real risk, the real problem for the SPD leadership is still ahead and that is the membership ballot.

"With the membership [ballot] it will be a very different game, turnout will be very key," he continued. "Whether the pragmatic majority that probably accepts this deal, although they will by no means love it, turns out to support this deal will be key."

In September's election, Merkel's Christian Democrat (CDU) party and her allies the Christian Social Union (CSU) only managed to win 33% of the vote, the worst result for the alliance since 1949 and far below the 42% she won in 2013.

The Chancellor subsequently attempted to form a coalition with the FDP and the Greens, however this broke down in November over issues including immigration, taxes and climate change.