EURO GOVT-Faith in ECB backstop helps Italian bonds recover
* German Bunds dip, Italian debt rebounds further * ECB backstop seen as crucial to current market calm * Heavy long bias towards periphery creates selloff risks By William James LONDON, Feb 28 (Reuters) - Italian bonds pared recent losses on Thursday as investors took stock of the country's political stalemate, with concerns over possible fresh elections offset by the European Central Bank's bond-buying backstop. The political crisis following indecisive election results in Italy deepened on Wednesday when two party leaders ruled out the most likely options to form a government, raising the chances of a fresh vote. But, the ECB's longstanding promise to buy bonds issued by struggling states if needed has helped to limit the selloff in Italian bonds, and was expected to continue doing so over the near term. Italian 10-year bond yields were 6 basis points lower at 4.76 percent while Bund futures fell 21 ticks versus Wednesday's settlement to 144.88. A recovery in equities also signalled the more positive market sentiment. "There will be a risk premium on Italian yields until a new government is formed and we know what they're going to do with structural and fiscal reforms," said Nick Stamenkovic, strategist at RIA Capital Markets in Edinburgh. "But, we're not going to see a return to the levels we saw a year ago because the ECB has pledged to use its balance sheet if necessary." Italian 10-year yields have now pared around 15 basis points of the 50 basis point rise seen earlier this week. Current yields are well above lows near 4.12 percent hit in January, but also far below the levels above 6 percent seen in mid 2011. SELLOFF RISKS PREVAIL Nevertheless, bond markets' risk-hungry start to the year, when investors loaded up on higher-yielding debt from across the region's struggling peripheral states, has left many exposed to further weakness in Italian BTP bonds. "Anyone who bought BTPs this year is now offside," a trader said. "Given the positioning in periphery, which is radically longer than it was six months ago, that doesn't really support things." The heavy bias this year towards betting on a rise in Italian bonds means that any fall in prices leads to lower profits or even outright losses for investors, giving a strong incentive to sell out quickly if the situation worsens - a potential snowball effect that could benefit German debt. "We continue to maintain a positive view on Bunds, with the view that yields go to 1.25 percent and possibly beyond," the trader said. Ten-year German yields were last at 1.47 percent, up 2 basis points on the day but still close to two-month lows hit on Wednesday at 1.42 percent. Concerns over major U.S. spending cuts due to start taking effect on Friday also gave background support to low risk bonds, although analysts said the impact would be felt over the medium term and was currently overshadowed by euro zone problems.
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