Italy yields up as political concerns nag, Syria eyed
* Reports Berlusconi to scupper coalition renew concern
* Italian debt resumes underperformance of Spain
* Bunds pare gains after lacklustre German debt sale
* But Syria crisis underpins demand for low-risk bonds
By Emelia Sithole-Matarise
LONDON, Sept 4 (Reuters) - Italian yields rose on Wednesday after media reports said former prime minister Silvio Berlusconi was threatening to pull the plug on the governing coalition.
Italy's yield premium over German Bunds climbed with the euro zone's benchmark debt underpinned by concern over Syria as U.S. lawmakers edged closer to approving a military strike to punish an alleged chemical attack on civilians.
Some Italian papers said on Wednesday that Berlusconi, who faces possible eviction from the Senate after a tax fraud conviction, was considering withdrawing his party's support from the left-right coalition government led by Enrico Letta.
Italian 10-year yields were up 6 basis points at 4.41 percent, resuming their underperformance of equivalent Spanish bonds, whose yields were up 2 bps at 4.50 percent .
"There's this debate over whether Berlusconi should be granted immunity and he is trying to ratchet up the pressure ... This puts Letta in a difficult situation," a trader said.
"We are going to get bellicose statements from Berlusconi's party in coming weeks and it could easily result in elections. The market won't really like that which is why we are seeing the Spanish outperformance of BTPs continuing even though we have supply tomorrow."
Spanish 10-year yields were last trading just 10 bps over Italian equivalents and the trader said they could close the gap or even trade below Italy's if Rome's political problems deepen. The yield spread neared parity last week over a divisive Italian property tax proposal but widened back to 16 bps after the government scrapped the plan.
SYRIA PROPS UP BUNDS
Top-rated Bunds trimmed gains after a German sale of 4 billion euros of new five-year bonds drew weaker demand than at a previous sale of similar maturity debt.
Underlying sentiment for Bunds remained firm, however, as concern over Syria outweighed this week's forecast-beating European and U.S. manufacturing data which reinforced bets the Federal Reserve would soon cut its bond purchases.
The U.S. Senate's Foreign Relations Committee agreed a draft authorisation on Tuesday for the use of force against Syria, paving the way for it to vote on Wednesday. President Obama also won the backing of key figures, including Republicans, for his call for limited U.S. strikes on Syria.
Bund futures were up 15 ticks on the day at 139.76, off a session high of 139.87 reached before the German auction result.
"One of the drivers behind this (auction result) is likely to be market confusion over the opposing factors of (U.S. Federal Reserve) QE (quantitative easing) tapering and potential military action in Syria," Rabobank strategist Lyn Graham-Taylor said of the German auction result.
"The weak bid/cover indicates that the QE effect is currently predominating in the bigger picture."
German 10-year yields were 1.1 bps lower at 1.94 percent, not far off their 1-1/2 year high of 1.98 percent reached two weeks ago. Many analysts saw little scope for a significant decline in yields before a European Central Bank policy meeting on Thursday and U.S. jobs data.
Strong gains in the payrolls data for August on Friday would cement expectations the Fed would scale back its bond-buying in October, while a weak figure would revive bets on a delay.
Economists polled by Reuters estimated U.S. payrolls expanded by 180,000 jobs in August while the unemployment rate remained steady at 7.4 percent.
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