EURO GOVT-Spanish, Italian bonds firm in face of political worries
* Italian, Spanish bonds supported by domestic buying
* Wednesday's Italian sale challenging but seen going smoothly
* Recovery seen short-lived as political concerns persist
By Ana Nicolaci da Costa and Emelia Sithole-Matarise
LONDON, Feb 12 (Reuters) - Spanish and Italian bonds rose on Tuesday as some domestic buyers took advantage of a recent sell-off, but the recovery could be temporary given political uncertainty in both countries.
Trade in the two periphery nations' paper has been choppy over the past week as Spanish Prime Minister Mariano Rajoy faced calls to resign over a corruption scandal while in Italy, former premier Silvio Berlusconi's comeback in polls less than two weeks before elections has unsettled investors.
Italy had to pay more to borrow one-year funds at an auction than it did last month. On Wednesday it faces a tougher challenge, issuing three separate bonds including an offering of 30-year paper for the first time at a regular auction since May 2011.
But analysts said the rally this session was a good indicator of demand, while the sale should benefit from ample Italian redemption and coupon payments due in February.
"Until yesterday we saw a significant concession. Logically one would have expected that to continue into today, but today there was a bit of buying," Ricardo Barbieri, strategist at Mizuho said.
"The tone of the market going into those auctions is good."
Ten-year Italian government bond yields were 11 basis points lower at 4.51 percent, having risen 37 basis points since late January.
The Spanish equivalent was 10 bps lower at 5.34 percent, having fallen 39 bps over the same period.
"We've had some decent buying, mainly domestics in Spain," one trader said.
Spanish bond prices showed little reaction to comments by European Central Bank chief Mario Draghi that Spain was on the right track towards economic recovery.
He also said the central bank could only consider activating its bond-purchase programme if there are major problems in the transmission of its monetary policy.
The ECB's intervention pledge has helped to greatly reduce Spanish borrowing costs in recent months even though the sovereign has not yet asked for help - a condition for the programme to be put into action.
Spanish short-term auction yields were mixed at a sale of 6- and 12-month bills.
POLITICS CAST SHADOW
The rebound in Italian bonds was, however, expected to fizzle out as the elections approach, as investors worry that a strong rally in the polls by Berlusconi could result in a fragmented parliament.
That could hamper Rome's ability to push through structural reforms which market analysts say are needed to cut the country's 2 trillion euro debt pile.
Those concerns were keeping some investors sidelined from Italian sovereign debt for now.
"We've done a bit (of buying) in Italy. But to do more we want to see some clarity coming from Italy on the results of the elections," said Rose Ouahba, head of fixed income at Carmignac Capital Plus which manages 808 million euros.
"We all know the impact of Berlusconi coming back on the political scene would be damaging for the Italian spread. We did not want to increase our exposure for now. We're looking more to increase our exposure if we have confirmation that we're not going to have a hung parliament," she said.
Reflecting the defensive view some analysts are taking on Italy, Unicredit strategists saw scope for further gains in favouring Irish debt, which rallied sharply last week after Ireland concluded a bank debt deal that will reduce its borrowing costs for the next decade.
They moved their "buy" stance on Irish 2018 bonds against Italy to a spread target of -50 bps from -30 bps.
"The reason for shifting out the target is to let the profit run and be in the position of capturing the current positive momentum as well as a possible overshooting of markets sentiment both in positive terms versus Ireland and in negative terms versus Italy," they said in a note.
At the euro zone's core, German Bund futures were 30 ticks down on the day at a settlement close of 142.55.
The contract has struggled to decisively break above 143.00 for two consecutive sessions which technical analysts say could pave the way to 143.15, the 200-day moving average which would herald further gains.
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