LONDON: German government bond yields dipped and the Italy-Germany bond yield spread widened on Thursday amid worries over the political situation in Italy, where new elections may prove necessary even as the country grapples with an economic slowdown.
Italy's former premier Matteo Renzi pulled his small party out of government on Wednesday, stripping the ruling coalition of its parliamentary majority and triggering political chaos while the nation battles a resurgent COVID-19.
A new election may not be the only course for Prime Minister Giuseppe Conte, but political uncertainty will remain for the foreseeable future, analysts said.
"President (Sergio) Mattarella may give Conte or some other figure the mandate to try and form a new coalition. Such an alliance could be very similar in composition to the existing coalition or it may try to engage other parties across the Parliament," Mizuho analysts said in a note.
"Regardless how this is resolved, (Italian) BTPs should be pricing in greater political risk ahead."
After recording their biggest drop since Sept. 11 on Wednesday at 5.2 bps, German 10-year government bond yields, the benchmark for the region, fell another basis point to -0.532% on Thursday.
The Italy-Germany bond yield spread widened by nearly three basis points on Thursday to 110 basis points.
Italy is also due to auction bonds later on Thursday, providing a test for appetite. Most euro zone governments have seen hefty demand for bonds in recent months amid unprecedented European Central Bank stimulus.
The moves on German Bunds run counter to other major government bonds around the world, where yields have been pushed up by the promise of a big stimulus package from US President-elect Joe Biden.
In addition, a higher-than-expected inflation figure in the United States may have put some upward pressure on US Treasury yields, though Federal Reserve officials did push back against the possibility of tightening policy for now.
US 10-year Treasury yields were up about 1.5 bps at 1.10% on Thursday morning.