LONDON: Italy's 10-year bond yield touched its highest in over two weeks on Tuesday, and the gap over safer German bonds held above the key 300 basis-point mark ahead of a deadline for Rome to re-submit its contentious budget plan to the European Commission.
The yield rise was tempered towards close of trade, as a bond auction saw the country sell 5.5 billion euros ($6.2 billion) worth of debt, meeting the Treasury's target.
Markets remained on edge, however. Prime Minister Giuseppe Conte said his government would be sending later on Tuesday its reply to the European Union about EU concerns over the country's 2019 budget.
It has until the end of the day to present a new budget to the European Commission or risk facing disciplinary action over its expansionary fiscal plans.
The Commission has threatened to impose penalties if the draft is not revised to conform with EU regulations but Rome has indicated it is unwilling to do this.
"It's a balancing act for (the European Commission), how to respond tomorrow morning to what Italy is presenting tonight," Valentijn van Nieuwenhuijzen, chief investment officer at NN Investment Partners told the Reuters Global Asset Allocation summit.
"Because if they go too forceful, and too aggressively, they might invite markets to be much more negative."
Italy's 10-year bond yields rose as high as 3.51 percent but pulled back to around 3.45 percent towards close of trade, flat on the day.
The closely watched gap between 10-year Italian and German government bond yields widened to almost 312 bps at one point but snapped back to 303 bps towards the close of trade . "If confirmed, the unwillingness of the government to change the deficit number for 2019 will remind markets that Italy remains an important source of uncertainty in the euro zone, providing further support for core yields and preventing the 10-year BTP/Bund spread from breaking below the 300 bps threshold," analysts at UniCredit said.
Euro zone policymakers have discussed using the bloc's bailout fund to stem contagion from Italy's debt woes to other indebted countries, the European Central Bank's chief economist Peter Praet said on Tuesday.
A spokesperson for the bailout fund, the European Stability Fund, said the finance ministers had been discussing the terms of access to precautionary credit lines to make the instruments more effective, but the talks were not specifically related to Italy.
Across the euro bloc, bond yields rose 1-2 bps on the day after the Netherlands sold 635 million euros of bonds maturing in 2042 and Germany auctioned just over 3 billion euros of two-year debt.
Germany's 10-year Bund yield climbed from Monday's almost two-week low around 0.38 percent to a session high of 0.412 percent, though it closed below that at 0.408 percent.
In the United States, 10-year, 30-year, and two-year yields fell to their lowest since Nov. 2 as Treasury markets opened after Monday's holiday.
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