UPDATE 1-Italy 2-yr debt sale edge costs up, Cyprus aid supports

Mon Mar 25, 2013 7:22am EDT

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MILAN, March 25 (Reuters) - Italy's two-year borrowing costs were little changed at auction on Monday, with investors weighing uncertainty over the country's political future against relief Cyprus agreed a bailout, keeping the euro zone intact.

The treasury sold 2.825 billion euros of two-year zero-coupon bonds, with a yield of 1.75 percent.

That was the highest level since December 2012 but only marginally higher than the 1.68 percent Italy paid at an auction on February 25, hours before inconclusive election results that triggered a political deadlock that remains unbroken.

The last-ditch bailout signed by Cyprus hours ahead of the debt sale saved the island's banking system and euro zone membership.

"The impact of the deal on Cyprus is likely to be limited as the market already bet on a compromise. I expect investors to focus on the domestic political outlook," Alessandro Giansanti, fixed-income strategist at ING.

No single party or coalition has won a big enough majority to govern, increasing the chances that a new election will have to be held in the next few months.

Despite the political impasse, Italian yields have only risen moderately over the past month as a pledge by the European Central Bank to buy the bonds of weaker euro zone countries continues to shield peripheral debt.

Giansanti said Monday's auction was a bit weak. "The treasury paid a limited uptick in terms of yield, but ... the demand was (only) 1.43 (times) the offer," he said.

A month ago the bid-to-cover ratio was 1.65. The treasury sold 3.825 billion euros of debt, just below the 4 billion that marked the top of its target range.

Pier Luigi Bersani, leader of the centre-left PD party whose alliance won a majority in the lower house of parliament but not in the Senate, is in talks with parties this week to see if he can form a government.

It is unclear how Bersani could secure a majority in the Senate.

The Bank of Italy's deputy director general, Fabio Panetta, said on Saturday the political stalemate and renewed financial market turbulence could undermine the country's recovery from its longest recession in two decades.

On Monday, Italy sold also two inflation-linked BTPei bonds maturing September 2018 and September 2023 respectively.

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