UPDATE 1-Italy's 2-yr debt yield falls to lowest since Oct 2010

Tue Nov 27, 2012 6:52am EST

By Francesca Landini

MILAN Nov 27 (Reuters) - Italy's two-year borrowing costs fell to their lowest in more than two years at an auction on Tuesday, as an agreement by Greece's international lenders to help cut its debt and release more aid helped market sentiment.

Investors have been reassured, at least for now, by the austerity measures carried out by Italy's technocrat government and the prospect of the European Central Bank's bond-buying scheme. That's helped Europe's third-largest economy steer borrowing costs down towards pre-crisis levels.

The treasury sold 3.5 billion euros ($4.54 billion) of two-year zero-coupon bonds, paying a yield of 1.923 percent -- down from 2.397 percent at a similar sale one month ago and the lowest since October 2010.

"The fall of the yield under the 2 percent threshold is a good result for the Italian treasury," said Luca Cazzulani, deputy head of fixed-income strategy at Unicredit in Milan. "The deal on Greece has eased tensions on the market and boosted demand for Italian paper."

Sentiment was bolstered after euro zone finance ministers agreed on Monday a package of measures that will reduce Greek debt to 124 percent of gross domestic product by 2020. Eurogroup Chairman Jean-Claude Juncker said the ministers would formally approve the release of aid to Greece, removing uncertainty over whether Athens could avoid near-term bankruptcy.

At Tuesday's auction, demand for CTZ zero-coupon bond was 1.5 times the offer and allowed Rome to place the top planned amount of 3.5 billion euros. Italy also sold the whole targeted 1 billion euros of two inflation-linked BTPei bonds with maturity Sept. 2019 and Sept. 2026.

Tuesday's sale will be the last Italian zero-coupon bond to be completed this year. Although Rome has already met more than 95 percent of its challenging borrowing target of 460-465 billion euros for 2012, lower rates have encouraged the treasury to continue to sell debt.

Even with yields falling, Rome's debt looks attractive to investors. Liquidity is abundant on the bond market and returns on debt of core euro zone countries are negative or very low, traders said.

French T-bill yields dipped at an auction on Monday into negative territory in the first debt sale after Moody's stripped Paris its triple A rating last week. The same day, Belgium's borrowing costs fell to new record lows at 2.25 percent on the 10-year benchmark bond.

However, short-term debt like that sold at Tuesday's auction is usually bought by Italian banks. A bigger test of how international investors view Italy will come on Wednesday, when Rome will offer 7.5 billion euros of six-month bills, and then on Thursday, when it will sell up to 6 billion euros of five- and 10-year bonds.

While bond yields are returning to normal, the Italian economy will remain mired in recession next year. Paris-based Organisation for Economic Co-operation and Development said on Tuesday the euro zone's third-largest economy will shrink by 1 percent in 2013 and the fiscal deficit will be far above target.

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