March 20, 2012 / 1:17 PM / 6 years ago

EURO GOVT-Italy yields rise as reform talks start

* Spanish yields rise after Moody's warns on fiscal targets
    * Bunds' rebound seen short-lived on resilient equities
    * German 10-yr yields could rise to 2.20 pct in coming month

    By Emelia Sithole-Matarise	
    LONDON, March 20 (Reuters) - Italian and Spanish bonds came
under pressure on Tuesday, prompting a rise in low risk German
debt, as Italy's Mario Monti started talks with unions over
labour reforms that could make or break his government, stoking
worries about fiscal slippage.	
    Investors were lured back into German bonds after 10-year
yields broke last week above 2 percent, the upper end of the
year's trading range to that point. 	
    But the rebound from last week's sell-off could be
short-lived with yields expected to remain above 2 percent in
the coming month against a backdrop of improved U.S. and German
economic data that has lifted U.S. equities to within sight of
record highs.	
    Still, yields on bonds issued by Spain and Italy rose on
investor caution as Prime Minister Monti met unions over labour
reforms seen as crucial to helping the country revive economic
growth and pay down its massive debt.	
    "Labour market reforms are absolutely pivotal to improving
the medium-term growth outlook which has been very poor
recently," said RIA Capital Markets strategist Nick Stamenkovic	
    "So if we see signs of further structural reforms going in
place that will help Italy, but if we see signs that Mr Monti
starts to water down structural reforms the market will take
that very badly and Italian bonds will come under pressure."    
    Italian 10-year yields were last up 4.3 bps at 4.88 percent
, widening the spread over German Bunds by 7 bps to
286 bps.	
    The equivalent Spanish yield was up 4.7 bps at
5.22 percent after ratings agency Moody's said Spain's fiscal
outlook remained challenging despite recently softened deficit
targets. Moody's said, however, that the new target did not
affect its A3 bond rating with a negative outlook because a
deviation from targets had already been taken into account.	
    Some strategists expect Italy to keep outperforming Spain
after data showed Spanish banks' bad loan rates rose in January
to their highest since August 1994, suggesting the sector is not
yet out of the woods as the country slides into recession."We're quite constructive still on Italy," said UBS
strategist Gianluca Ziglio. 	
    "If we get a smooth process in terms of the labour market
reform then there's no reason why BTPs shouldn't tighten even
more against Bunds and outperform Spain as well because we think
the Spanish problem is much more important and relevant than
issues in Italy."	
    June Bund futures were last up 19 ticks on the day
at 135.79 while the 10-year German cash yield was down 1.4 bps
at 2.03 percent, retreating from this year's high of 2.07
percent reached last week.	
    "We're seeing a bit of a bounce off last week's sell-off but
I don't think it's going to be very pronounced. I wouldn't
recommend investors chase this rally," said RIA Capital Markets
strategist Nick Stamenkovic.	
    "Whilst the Bank of England, the Fed and ECB are not going
to raise rates any time soon the chances are that any further
monetary accommodation starts to lessen and one of the key
supports for core government bonds starts to fade and yields
will start to move modestly higher over the next few weeks." 	
    He saw the German 10-year yield testing 2.20
percent over the next month.	
    Credit Agricole strategists said that if Bund yields broke
above an important technical level over the coming days, it
would suggest they had entered a new higher range.	
    "In this context, the 10-year Bund would have to stay above
2 percent. Further validation of last week's move would be if
the Bund can test its 200-day moving average - around 2.12
percent - like the 10-year T-note and UK gilt have done," they
said in a note.
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