May 30, 2013 / 11:34 AM / 4 years ago

Italy's debt costs rise in hint rally of the vulnerable may be over

MILAN (Reuters) - Italy's long-term borrowing costs edged up at an auction on Thursday for the first time in three months, adding to signs that a 10-month-long rally in vulnerable euro zone bonds may be faltering.

They remained well below levels that triggered concern during the height of the euro zone debt crisis, however.

The rise in long-term yields followed an uptick in Rome's short-term debt costs on Wednesday and a rise last week in Spanish debt. The moves reflected investors' concerns the Federal Reserve may soon begin unwinding its ultra-loose monetary policy program - withdrawing some global liquidity.

That has generally lifted bond yields across the board, although bonds in peripheral euro zone economies have fared worse than those of core Germany.

The impact of the European Central Bank's pledge to buy bonds of troubled euro zone economies in certain circumstances may also have run its course in terms of how far down it can push yields, although it is likely to remain a backstop for the market.

Analysts said the auction was positive in terms of the current cautious market mood, but some said bond markets could become rough for peripheral countries as investors turn to countries' economic fundamentals they have long neglected.

"Amid increasing signs that the tide is turning against peripheral euro zone bond markets... Italy was still able to pull off a strong auction," said Nicholas Spiro, managing director at Spiro Sovereign Strategy.

Rome sold 3 billion euros of 10-year bonds at 4.14 percent, its highest level since March. At a similar sale a month ago, it had paid 3.94 percent, the lowest since October 2010.

The treasury also placed 2.75 billion euros of 5-year bonds at 3.01, up from 2.84 percent one month ago.

LONG WAY FROM HIGHS

Despite Thursday's rise, Italy's 10-year borrowing costs remained well below 6.20 percent posted at an auction at the end of June last year, before the pledge by the ECB to buy bonds of weaker euro zone countries prompted a rally in peripheral government bonds.

"Yields rose but this reflects what we have seen in the secondary market since last week after (Fed Chairman) Ben Bernanke's speech," said Luca Cazzulani, fixed income strategist at Unicredit.

Bernanke said last week that the U.S. central bank could decide whether to reduce its $85 billion in asset purchases every month at one of its "next few meetings," depending on economic data.

The day following Bernanke's speech Spain had to pay higher rates on medium-term debt for the first time since early February at a debt sale.

"Italy's bond market, like its Spanish counterpart, is entering into a much more perilous phase," said Spiro.

The domestic economy remains in its longest recession since the World War Two, he said, adding Rome has embarked on the difficult task to cut taxes while sticking to the austerity path promised to Brussels.

"Investors are start asking themselves whether there will be a recovery in the Italian economy," said a Milan trader.

The possible withdrawal of global liquidity from the financial market would have serious consequences for vulnerable countries that are still fighting to reform themselves and kick-start their economies.

Italy, which also sold 50-yr bond via private placement on Wednesday, has already met more than 50 percent of its borrowing target for the whole 2013.

Additional reporting by Ana Nicolaci da Costa and Giulio Piovaccari, editing by Silvia Aloisi/Jeremy Gaunt

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