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Italy's bond yields drop on fresh bid to form government

Fall comes as two polls show that most Italians want to stay in the euro, countering earlier jitters

London

INVESTORS returned to the Italian government bond market on Thursday, pushing the country's borrowing costs lower, as a fresh attempt to form a government eased fears of an early election.

Italy searched for a last-minute exit from almost three months of political turmoil on Wednesday, with its biggest party 5-Star Movement looking to make a renewed attempt to form a coalition government with the right-wing League.

In addition, two polls showed that most Italians want to stay in the euro, countering some concerns about the eurosceptic outlook of the two largest parties, the League in particular.

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"The market is just rallying, hoping that new elections may be avoided. That's what's behind the rally in BTPs (Italian bonds)," said ING strategist Martin van Vliet.

"The market was preparing for snap elections which would be seen as de facto referendum on euro membership. But with these two parties looking to get together, the 'referendum' could be avoided."

Italy's 2-year government bond yield, which has been the focus of a sell-off, was down as much as 102 basis points at 0.98 per cent.

The benchmark 10-year bond yield was down 29 bps at 2.76 per cent, while the closely watched Italy/Germany 10-year bond yield spread tightened to 237 bps, as much as 33 bps tighter than Wednesday's close.

Italian 5-year credit default swaps fell 19 bps from Wednesday's close to 233 bps, according to data from IHS Markit.

These moves erase much of this week's losses. Italian yields hit multi-year highs on Tuesday as the political crisis unfolded in Rome. However, analysts warned that the Italian situation was still unpredictable and that it was too early to suggest that Thursday's move represents a sustainable recovery.

"The situation is likely to remain fairly fluid for now and while short-term stability may prevail, we fail to see how BTP-Bund spreads can tighten substantially from here in the near-term," RBC said in a note.

Elsewhere, eurozone inflation numbers for May are due, and analysts are bracing for a higher-than-expected figure after several eurozone countries reported a sharper rise in consumer prices than forecast.

On Thursday, French inflation rose in May to its highest level since August 2012 at 2.3 per cent, adding to strong inflation readings from Germany and Spain the day before. High-grade eurozone bond yields were higher 1-4 bps across the board.

The yield on Germany's 10-year government bond - the benchmark for the bloc - rose 4 bps to 0.39 per cent. Some of the country's inflation readings were well above the European Central Bank's targeted inflation of just below 2 per cent, so the overall eurozone figure due on Thursday will be closely watched.

"A high inflation reading would make it easier for the ECB from a presentation point of view to announce further tapering of QE (quantitative easing) from September," said ING's Mr van Vliet, adding that the bank could announce it at the June or July policy meetings. REUTERS