UPDATE 1-Italy's six-month borrowing costs fall to record low

Fri Apr 26, 2013 6:25am EDT

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By Lisa Jucca

MILAN, April 26 (Reuters) - Italy's six-month debt costs fell to a record low at an auction on Friday as investors expected prime minister-designate Enrico Letta to bring together rival parties and quickly form a government.

Analysts also said expectations of an interest rate cut in the euro zone and the current hunt for returns were also helping to drive down Italian borrowing costs.

"The fall in yields is impressive. Beyond expectations for a rate cut, that are in any case offering support, markets are confident that Italy is going to form a government," said Sergio Capaldi, an analyst at Intesa Sanpaolo.

Rome sold 8 billion euros ($10.4 billion) of bills maturing in October at 0.503 percent, down from the 0.83 percent the treasury paid at a similar sale one month ago. This was the lowest level for Italian six-month borrowing costs since the introduction of the euro. Italian yields in the lira era were also much higher.

However, the bid-to-cover ratio - a gauge of investor demand - fell to 1.40 from 1.64 previously.

Italy has been in a political limbo since inconclusive elections at the end of February led to a parliamentary split between three main political forces.

Moderate centre-left politician Letta is attempting to end a two-month political gridlock by forming a broad coalition government. He said early-stage talks to form a government were "encouraging", but problems remained in reaching a deal with the Silvio Berlusconi-led centre-right.

Although viewed by investors as a better prospect than snap elections, such a government could turn out to be fragile given the diverse composition of the political base expected to support it.

"The political situation in Italy remains extremely fluid. Italy's next government will be a booby-trapped one from the outset, with all sorts of potential triggers to undermine it and cause its eventual collapse," said Dr Nicholas Spiro, Managing Director at Spiro Sovereign Strategy.

"Although it will have a solid majority in parliament, the government is likely to be riven by conflicts and permanently weakened by the prospect of an early election.

On Monday the treasury will offer up to 6 billion euros of five- and 10-year bonds in the last debt sale scheduled for April.

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