TREASURIES-U.S. bonds edge up as spending cuts kick in

LONDON, March 4 Mon Mar 4, 2013 6:29am EST

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LONDON, March 4 (Reuters) - U.S. bond prices inched up in Europe on Monday as automatic spending cuts took effect after lawmakers failed to reach a deal to avert them, raising concern the fiscal drag could hit growth.

Political instability in Italy as it struggled to form a government after inconclusive elections last week also supported demand for low-risk debt.

President Barack Obama and congressional Republican leaders last week failed to find an alternative budget plan to avert the $85 billion across-the-board cuts from kicking in on Friday.

They could still halt the cuts in the weeks to come, but neither side has expressed confidence it will be able to do so.

The 10-year T-note was last up 2/32 in price to yield 1.839 percent, one basis point less than in late U.S. trade on Friday and not far from a one-month low of 1.836 percent set last week. The T-note future was 3/32 up at 131-28/32.

"We had the sequester cuts triggered on Friday and things are starting to heat up again in Europe... The political situation in Italy continues to be unstable and we had the anti-austerity marches in Portugal at the weekend. This is helping the bid here," a trader said.

"We don't have any auctions this week and we have buybacks so the market will probably do OK," he added.

Treasuries were unfazed by data from the Institute for Supply Management on Friday showing production at U.S. factories grew last month at its fastest pace since June 2011, as traders focused on the spending cuts and events in Italy.

The 30-year T-bond was last 3/32 higher in price to yield 3.05 percent, one basis points less than in late New York trade on Friday.

Some strategists see negotiations on the budget cuts dictating market direction in coming weeks.

"Even in scenarios where these cuts are implemented in a targeted manner, the resulting fiscal tightening would be more than is priced in by the Treasury market," Barclays strategists say in a note.

"Therefore, we maintain that the Treasury yields still have room to decline, led by the long end. The latter is because the rally so far has been led by the shorter end of the Treasury curve."

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