Italy lags in periphery rally before confidence vote
* Italian bonds rise but lag some peripheral peers
* Trade seen range-bound before Italy's confidence vote, ECB
* Portuguese bonds outperform low-rated debt
By Ana Nicolaci da Costa
LONDON, Oct 1 (Reuters) - Italian bonds rose on Tuesday but lagged a rally in peripheral bonds a day before Italian Prime Minister Enrico Letta faces a vote of confidence in a bid to draw a line under political tensions.
Dissent within former premier Silvio Berlusconi's party Monday raised expectations among investors that the government could survive but even if it does prospects for stability and reform in Italy look more fragile than ever..
With the potential of an imminent Italian election averted, low-rated debt rose and safe-haven German bonds fell as investors shrugged off for now the U.S. government's first partial shutdown in 17 years.
"In the short-term, Italian debt are likely to undeperform their peers, underperform Spain. I would say a widening of the spreads is the most likely scenario," Elwin de Groot, senior market economist at Rabobank said.
Ten-year Italian government bond yields fell 4.1 basis points to 4.53 percent and Spanish equivalents were 8.2 bps lower at 4.22 percent.
Portuguese bonds outperformed, with one trader citing talk of a big buyer late on Monday. Ten-year Portuguese yields fell 25 bps to 6.60 percent.
"There was a big buyer late last night, so it's an overspill from that," the trader said.
An second trader said talk of another long-term refinancing operation, after European Central Bank President Mario Draghi flagged that possibility last week, could also be helping.
The ECB meets on Wednesday and is expected to stick with its accommodative monetary policy.
Analysts said debt markets had priced in the first, albeit partial, U.S. government shutdown in 17 years.
Lawmakers could not break a political stalemate, raising fresh concerns about whether Congress can meet a crucial mid-October deadline to raise the government's $16.7 trillion debt ceiling and avoid default.
German Bund futures fell 26 ticks to 140.24 but analysts said the backdrop was broadly supportive for safe-haven assets and they could still rise going forward.
"That (The muted market response) is a sign that the market has on the one hand already priced in the negative economic impact of the government shutdown but obviously they are not pricing in, at least at this point, the consequences of a failure to raise the debt ceiling," de Groot added.
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