October 10, 2018 / 10:49 AM / a month ago

UPDATE 2-Italian bond yields drop as Tria looks to restore market confidence

* Tria: Govt will do all it can to recover market confidence

* Italy’s 2-year yield down 4 bps on day, depressed by remarks

* Italy/Germany 10-year yield spread tightens to 296 bps

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Virginia Furness

LONDON, Oct 10 (Reuters) - Italian bond yields edged lower on Wednesday, stemming heavy losses so far this week, after Economy Minister Giovanni Tria said the government will do all it can to recover market confidence.

Tria moved to reassure markets after a volatile early trading session, saying the Italy/Germany spread did not reflect Italy’s economic fundamentals from the point of view of debt sustainability.

The two-year Italian government bond yield fell by eight basis points to 1.64 percent after his comments, before settling at 1.68 percent by the close.

Italy’s 10-year yield was down two basis points at 3.51 percent, while the spread over Germany tightened to 296 basis points.

Yields had moved higher earlier in the session after a senior Moody’s Analytics economist told La Stampa newspaper that Italy’s budget was “a mistake,” adding to comments from a senior League lawmaker that a downgrade of the Italian debt by credit rating agencies is possible.

Moody’s and S&P Global, which both rate Italy two notches above junk, are due to provide an updated opinion on Italy’s credit rating in the second half of October. Analysts say around one downgrade is already priced in.

“The outlook after the downgrade is now the focus,” said DZ Bank strategist Rene Albrecht. “It will be a volatile session again but we think the government is now more spread-sensitive.”

Analysts say the recovery in bond yields is partly a result of an expectation that the government will row back on some of its budgetary promises, despite comments from senior politicians to the contrary.

“There is hope in the market that the government makes some concession on the headline deficit target to the commission,” said Antoine Bouvet, rates strategist at Mizuho.

“There is a well-defined pattern of governments buckling under market pressure because if yields rise to higher levels then the debt becomes less sustainable.”

On Tuesday, Italy’s parliamentary budget office refused to validate the multi-year budget plan, saying the forecasts for economic growth were excessive.

But Italy remains committed to its budget forecast, Tria said, following comments from the leaders of the ruling populist coalition, Luigi di Maio and Matteo Salvini, who reiterated that the budget would not be amended.

Analysts say should the spread of Italy’s 10-year bond yield over Germany remain above a 300 basis point “threshold”, the government would likely move to soothe markets.

European banking supervisors have stepped up their monitoring of liquidity levels at Italian banks after the sharp increase in bond yields, though there was no cause for alarm, a senior EU source said on Tuesday.

Elsewhere euro zone bond yields were up to one basis point higher, with Germany’s 10-year yield, the benchmark for the region, at 0.55 percent,.

Reporting by Virginia Furness; Editing by Janet Lawrence

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