Italian bond yields dip but set for biggest weekly rise since October

AMSTERDAM: Italian bonds showed some recovery on Friday as yields dipped, but borrowing costs were set for their biggest weekly rise in 12 weeks as the focus remains on the political uncertainty in Rome.

Italian Prime Minister Giuseppe Conte resisted calls to resign on Thursday after a junior coalition party led by former premier Matteo Renzi pulled out of the government on Wednesday and stripped it of its majority.

Instead, Conte signalled he wanted to take his fight for survival to parliament, with his main coalition partners backing plans to try to find support among opposition ranks to prop up the administration.

He will address Italy's Chamber of Deputies on Monday, followed by a vote of confidence expected to indicate whether he can battle on.

Renzi told Italian daily La Stampa that he did not believe Conte had the backing to win a confidence vote scheduled for next week.

On Friday, Italy's bond market was poised to end the week calmer, as 10-year bond yields were down 2 basis points at 0.59%.

"We see new elections as the worst possible outcome for BTPs, but this is highly unlikely, in our view," Societe Generale analysts Jorge Garayo, Ninon Bachet and Adam Kurpiel told clients, echoing a view held by many bond analysts.

"There is still a chance that PM Conte will manage to secure support after deliberations with Renzi and other parliamentarians. This would be the best outcome for BTPs," they said, referring to Italian government bonds.

But several sessions of hefty sell-offs this week put 10-year yields on track to end the week 9 basis points higher, their biggest weekly rise since the week ending Oct. 23.

BTPs were outperforming German bonds on Friday, pushing down the closely watched gap between German and Italian 10-year bond yields to 112 basis points, down from seven-week highs around 118 bps hit on Thursday.

But the spread, effectively the risk premium Italy pays on its debt, is up over 10 bps this week, after falling to its lowest since 2016 below 100 bps last week.

Analysts at Mizuho expect it could widen out to 130-150 basis points until the issue is resolved, although support from the European Central Bank's asset purchases are expected to keep a cap on the sell-off.

The Italian government has approved a new stimulus package worth 32 billion euros to prop up its coronavirus-battered economy, which will push this year's budget deficit to 8.8% of GDP from the current goal of 7%.

Elsewhere, German 10-year yields, the euro area's benchmark, were up 1 basis point to -0.54% after two consecutive days of sizeable falls.