Political crisis hurts Italian debt before auction
* Premier Enrico Etta to meet president on political crisis
* Italy borrowing costs likely to rise at debt sale
* Italy 10-year yields inch back above Spanish equivalents
By Emelia Sithole-Matarise
LONDON, Sept 27 (Reuters) - Italian debt yields rose further above German Bunds on Friday, extending the previous day's rise on concerns over the survival of the country's ruling coalition ahead of a big bond sale.
Italian bonds have come under fresh pressure since Silvio Berlusconi's centre-right party renewed threats to pull out of the coalition if the former premier is ejected from parliament in a Senate committee vote due next week.
Prime Minister Enrico Letta is expected to meet President Giorgio Napolitano on Friday to discuss the crisis, which has loomed ever closer since Berlusconi was convicted of tax fraud last month.
The country's fractious government will also try to work out how to avert a planned rise in sales tax while reining in a budget deficit which is overshooting European Union limits. Berlusconi's party has threatened to walk out if the tax goes into effect. [ID:nL5N0HM37V}
The premium investors charge Italy to borrow over 10 years above German benchmarks was 3 basis points up on the day at 259 bps, its highest in over a week. Italian 10-year yields were 3 basis points up at 4.37 percent with Spanish equivalents also up 2 bps at 4.36.
"Overnight developments increased the risk that the coalition government could break up, increasing the chances that another election might be possible," RIA Capital Markets strategist Nick Stamenkovic said.
"Supply should go OK but political worries will weigh on Italian bonds. Against this backdrop it's difficult to see Italian bonds making much headway against Germany and Spain."
SUPPLY TO GO OK
While borrowing costs for Italy are likely to edge up at Friday's sale of up to six billion euros of five and 10-year bonds, this week's price falls are expected to draw investor demand, particularly from domestic buyers.
"We expect decent take-up overall as pre-auction concessions should offset the recent headline noise," Commerzbank strategists said, noting a 10 basis point spike on Thurdsday in the December 2018 and March 2024 paper.
"The underperformance versus Spanish government bonds also picked up momentum again, which could attract relative value interest in addition to the typical domestic support," they said in a note.
Spanish yields fell below Italy's for the first time in 18 months earlier in September but Italian bonds had clawed back ground over the past week after Berlusconi seemed to step back from threats to topple the government. The flareup of political turmoil is seen driving Italian yields further above Spanish ones in coming days.
Other euro zone debt held largely steady, with German Bund futures last 7 ticks lower at 139.80 and cash 10-year yields 0.7 bps up at 1.78 percent.
A potential U.S. government shutdown on Oct. 1 should budget negotiations in Washington reach an impasse underpinned safe-haven Bunds but investors were refraining from extending positions ahead of a European Central Bank policy meeting and U.S. non-farm payrolls report next week, strategists and traders said.