* Berlusconi says Italy’s coalition must continue
* Italian services data beats expectations
* Italian 10-year yields hit six-week lows
* Bunds fall on better-than-expected U.S. ISM data
By Ana Nicolaci da Costa and Marius Zaharia
LONDON, Aug 5 (Reuters) - Italian bond yields hit their lowest since mid-June on Monday after services data beat forecasts and comments from centre-right leader Silvio Berlusconi soothed investor concern about the fragile government.
Berlusconi supporters protested in Rome on Sunday against his tax fraud conviction but he said the coalition of his People of Freedom party and the centre-left Democratic Party of Prime Minister Enrico Letta must continue.
That reassurance was well complemented by data showing Italy’s services sector shrank in July at its slowest pace since going into a downturn in mid-2011, and euro zone business expanded for the first time in 18 months.
When the economic outlook brightens, investors tend to have more appetite for riskier assets. Italian bonds held their own as German Bunds, the euro zone benchmark, sold off in the late part of the session in reaction to better-than-expected U.S. ISM services data for July.
“A lot of people thought last week that (the Berlusconi case) would cause the coalition to collapse ... Also Italy is still mired in recession, but the dynamics are not so negative anymore,” said Marius Daheim, chief strategist at Bayerische Landesbank in Munich.
Ten-year Italian government bond yields were last 1 basis point lower at 4.28 percent, having dropped as far as 4.23 percent earlier.
Italian bonds have largely weathered the rise in political risk thanks in part to the attractive yield they offer and the support from the European Central Bank’s bond-buying programme.
Cash flow was also in Italy’s favour. Barclays strategists expect Italian redemptions and coupon payments for the remainder of the year to be higher than the amount of bonds sold by 18 billion euros.
For all these reasons, investors are sticking with their Italian bonds for now.
German Bund futures fell 40 ticks on the day to 142.20, while 10-year cash yields rose 3.6 basis points to 1.69 percent, with most of the day’s move coming after the U.S. data.
Traders cautioned against reading much into the move, given that trading was thin. At the end of the European close, volumes were about 420,000 lots, compared with 737,000 on Friday and over 1 million last Wednesday.
The timing of any move by the Federal Reserve to reduce monetary stimulus is more likely to depend on the labour market than on the services sector.
“Most people still expect tapering to happen either in September or December. I‘m not sure many of them changed their view based on today’s data, there were very few flows today,” one trader said.