CORRECTED-Italy 3-year yields to dip under 2 pct at Friday sale

Fri Jan 11, 2013 3:55am EST

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MILAN Jan 11 (Reuters) - Italy's borrowing costs are set to dip at an auction on Friday, pushed down by solid demand from investors sniffing round for attractive returns as they kick-start their investments for the year.

Yields on three-year paper could fall below 2 percent to reach levels not seen since March 2010, confirming that the European Central Bank's pledge to intervene in the bond market is still one of the most powerful drivers for Italian debt.

Concerns over Italian elections remain subdued, as investors bet on the reform policies introduced by the technocrat government of Mario Monti continuing after February's vote.

On Thursday Rome will offer up to 3.5 billion euros of its BTP bond maturing on December 2015 and up to 1.5 billion euros of two five-year floating rate CCTeu notes.

"I expect the three-year bond sale to enjoy strong demand while it may prove more challenging for the treasury to sell the floating rate notes," said Raj Badiani of IHS Global Insight, adding however the amount of CCTeus on sale was minimal.

Market sentiment is positive and hunger for risky assets pushed the yield premium for 10-year Italian BTPs over their German Bund equivalent to under 265 basis points on Thursday, the lowest since July 2011.

One-year borrowing costs fell by more than 50 basis points at an auction on Thursday, feeding expectations of a similar drop at Friday's sale.

"Looking at current market levels, the cost of funding (on the three-year BTP) should drop by 50-60 basis points (from the previous month's sale)", Luca Cazzulani and Chiara Cremonesi at Unicredit said in a note.

The treasury paid a yield of 2.50 percent at an auction in mid-December, a few days after Monti announced his intention to resign before the end of 2012.

After a short period of market turmoil, Italian debt has seen a return of investor demand and is still benefitting from a buying spree for high-yield assets which began at the start of this year after the United States averted a fiscal cliff crisis.

The domestic electoral campaign however remains in the background.

"Regardless of the outcome of the elections there will be strong market pressure for Monti to be involved in some capacity in a government built around a center-left coalition," said Badiani.

"He is seen as a guarantor of Italy continuing on the reform path," said a strategist who did not want to be named.

Analysts added investors felt safe buying peripheral bonds in the two- to five-year maturity range as the ECB stands ready to buy euro zone bonds with a maturity up to three-years if required.

"Looking ahead the challenge both for Italy and Spain is to be able to issue comfortably on longer-term maturities," said Badiani.

Spain's sale of 5.8 billion euros of debt went smoothly on Thursday, kick-starting a challenging year when it will have to reach a gross borrowing target of 121 billion euros. (Reporting by Francesca Landini; Editing by Toby Chopra)

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