* Stability of Italian government at risk
* Demand falls at zero-coupon Italian debt sale
* Safe-haven Bunds rise on Syria tensions
By Marius Zaharia
LONDON, Aug 27 (Reuters) - Italy’s debt premiums rose on Tuesday as it made a lacklustre return to bond markets after a summer break, reflecting investor concerns over tensions within the country’s fragile ruling coalition.
Disagreement over a housing tax and a looming vote on whether to expel former premier Silvio Berlusconi from parliament after he was convicted of tax fraud have raised worries about the stability of Italy’s government.
Italy sold zero-coupon two-year bonds at 1.87 percent, a marginally higher yield than last month while demand as measured by the bid/cover ratio fell.
“Investors are not that keen on buying Italian bonds at the moment especially taking into account the political jitters, which are higher than in any other European country,” DZ Bank rate strategist Christian Lenk said.
He said a truer test of investor sentiment would be Thursday’s auction of up to 6 billion euros of five- and 10-year bonds, which he expected to show similar “mixed” results.
Ten-year Italian yields rose 2 basis points to 4.41 percent. With German Bunds firming as the threat of military action against Syria boosted safe-haven assets, the yield spread between the two widened 5 bps to 254 bps.
Italian Prime Minister Enrico Letta has set a deadline of a government meeting on Wednesday for a deal on the housing tax, while a Senate committee is due to begin hearing arguments on Berlusconi’s case on Sept. 9.
With a seasonal break in Italian debt issuance coming to an end and an economic upturn at risk if a political crisis takes hold, some analysts expect Italian/German yield spreads to continue to widen.
“A combination of lingering worries over the ruling coalition and concession ahead of upcoming supply suggests Italy will struggle to make any headway near-term and will continue to underperform Spain,” RIA Capital Markets strategist Nick Stamenkovic said.
The yield gap between Spanish and Italian 10-year bonds hit its tightest since March 2012 at 6 bps.
Bund futures rose 27 ticks to 140.31, while cash 10-year German yields fell 2 bps to 1.87 percent, even as data continued to show an improved economic outlook.
Germany’s Ifo business survey hit its highest in 16 months, beating expectations - the kind of data which helped push German yields to 1-1/2 year highs of 1.98 percent last week.
Concerns the United States was inching towards military action against Syria over a suspected chemical weapons attack offered support to safe-haven assets on Tuesday.
“It seems a bit odd to see Bunds rising like that after the Ifo figures ... but equities are being hit because of the Syria problems,” one trader said.