THE weekend agreement on an EU stability pact has driven Irish bond prices strongly ahead, leading to a fall in long-term interest rates. Meanwhile on the currency markets the deutschmark has lost ground.

Signalling optimism about the medium term outlook for Irish interest rates, the 5-year benchmark Government 2001 gilt gained 70p yesterday to close at £101.65. It closed at a yield - or long term interest rate - of 6.0 per cent from 6.12 per cent on Friday and 6.26 per cent on Thursday - the day before the stability pact was agreed.

Yesterday's gain followed a 90p gain in the final hour of trading on Friday after the agreement on the stability pact was announced.

The longer maturity 10 year benchmark Government bond gained 50p to close at £108.75 a yield of 6.62 per cent from 6.68 per cent at the end of last week. It has fallen from 6.79 per cent before the pact was agreed. Yesterday's rise in the 2006 bond followed a 100p gain in the last hour of trading on Friday.

Irish bonds outperformed other European bonds yesterday, but Spain and Italy also benefitted from the optimism about European Monetary Union.

Market sources said that the differential between bond yield Ireland and German has narrowed by between 0.15 and 0.25 of cent age point since the agreement on a stability pact. This shows market confidence that Ireland will participate in the move to monetary union.

In the 5 year maturity bonds - those indicating the direction of interest rates after the planned launch of the single currency in January 1999 - the yield differential between Irish and German bonds narrowed by 0.15 of a percentage point to 1.53 per cent yesterday. The 10 year differential narrowed from 0.92 to 0.86 of a percentage point.

Throughout Europe markets rose strongly yesterday with bourses, bonds and the dollar boosted by the deal over an EU stability pact. It helped stock markets recover ground after last week's volatility and Wall Street opened strongly following news of a merger between aerospace giants Boeing and McDonnell Douglas.

Analysts said the pact bolstered optimism that Europe's single currency project would go ahead on time in 1999 and increased the chance of a broad-based economic and monetary union (EMU) that would include Italy and Spain. It was also seen lowering interest rates in Europe, thereby buoying the dollar and yen against European currencies.

On the currency markets the deutschmark lost ground as investors felt that Germany had to make some compromises in negotiating the stability pact. Investors also fear that the euro may not be as strong as the mark.

As funds moved into sterling, the pound traded late in the day just below parity. It gained more than a pfennig against the mark to close at over DM2.58.

Meanwhile the German Finance Minister Mr Theo Waigel said he was satisfied with the stability pact struck at the Dublin summit to underpin the solidity of the planned euro currency. But, he warned that political discretion in allowing states in recession to exceed the Maastricht treaty's fiscal criteria without being penalised must not undermine the independence of the planned European central bank. A so-called stability council, in which countries taking part in monetary union were represented, should have only advisory and not decision-making powers, he said.

"This should not act as a counterweight to the European central bank," he told reporters after a meeting of his Christian Social Union (CSU) party in Munich. Agreement on the stability pact has helped the EU clear an important hurdle towards launching the single currency in 1999.

EU leaders agreed in Dublin to exempt from automatic fines any country which overshoots the Maastricht deficit goal of three percent of gross domestic product if its economy shrinks by more than two per cent in a given year. Countries whose output shrinks by over 0.75 percent will be able to plead "exceptional circumstances to avoid fines.