Italian debt lags Spain ahead of Rome auction

Thu Sep 12, 2013 4:18am EDT

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* Italian yields seen rising further above Spain's

* Underperformance, domestic investors to support Italian sale

* Ten-year German yields struggle to rise much above 2 pct

By Ana Nicolaci da Costa

LONDON, Sept 12 (Reuters) - Italian bonds lagged their Spanish counterparts as Rome prepared for a bond sale against a challenging backdrop, with investors pricing in a simmering political crisis in Rome and plans to issue more debt.

Italy will offer up to 7.5 billion euros of paper maturing in 2016 and 2028, as well as floating rate bonds.

Italian bonds' recent underperformance and appetite from domestic investors should underpin the sale, but any market relief will be short-lived as they remain vulnerable to adverse political developments, analysts said.

Prime Minister Enrico Letta warned on Wednesday that political turmoil was driving up Italy's borrowing costs as the future of Silvio Berlusconi remained uncertain.

The former premier faces possible expulsion from parliament following a conviction for tax fraud last month, with his supporters alternating pledges of loyalty with threats to bring down the government if he is forced out.

"We (have seen) quite a concession ahead of the auction, both at the short end and the longer and so I think that should enable supply to be relatively well-absorbed," Nick Stamenkovic, bond strategist at RIA Capital Markets said.

"Even so, it's difficult to see a strong rally in BTPs given the uncertain political outlook. Consequently I think Spanish bonds continue to outperform Italian bonds in the near term."

Ten-year Italian bond yields were up 1.4 basis points at 4.54 percent and the Spanish equivalent were 1.4 basis points lower at 4.48 percent, widening the spread between the two to 5 basis points from 3 bps on Wednesday.

Italian yields overtook Spanish ones for the first time in 18 months this week and analysts are expecting the spread to widen, also citing Italy's intention to issue more debt in 2013 while Spain plans to scale back monthly bond offerings.

At the other end of the credit spectrum, German bonds rose in tandem with U.S. Treasuries after strong demand at a 10-year U.S. auction.

Bunds were were 41 ticks higher at 137.51.

Ten-year German bond yields were 3 basis points lower at 1.97 percent, having hit a 1-1/2 year high at 2.059 percent on Friday. It has struggled to rise much above 2 percent in recent sessions.

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