Italian bonds edge up as debt exchange draws strong demand

Mon Nov 18, 2013 12:14pm EST

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By Marius Zaharia and Ana Nicolaci da Costa

LONDON, Nov 18 (Reuters) - Italian bonds edged up on Monday as investors attracted by prospects of a more stable government and ultra-easy central bank policy snapped up the five-year debt on offer in an exchange operation.

The Treasury assigned 3.3 billion euros of benchmark December 2018 bonds in exchange for five bonds due in 2015 and 2017 in a bid to ease its near-term repayments.

The size of Monday's debt exchange was double the average of the previous seven, according to ING, and analysts said that showed such offers can efficiently lengthen the maturity of Italy's debt if done regularly.

"The key takeaway was that Italy has plenty of instruments to ease its debt burden and smoothen its issuance," said Michael Leister, strategist at Commerzbank.

Ten-year Italian bond yields fell 2.5 basis points to 4.07 percent, close to November's five-month lows of 4.04 percent. The yield premium it offers over equivalent German Bunds was little changed at 239 bps.

But some analysts said scope for the yield premium lower-rated bonds offer over Bunds to narrow further was limited.

"Most of the decline in the spread coming from the decrease of the systemic risk is behind us. We are going to see further spread tightening but much less," Giordano Lombardo, Deputy CEO, Pioneer Investments, told the Reuters Global Investment Outlook Summit.

"We are not very far from fair value...probably we have another 50 bps (of tightening) left to fair value and this is mainly due to domestic policies, on reforms."

The diminishing risk of the Italian government collapsing also supported the country's bonds. Former premier Silvio Berlusconi, facing expulsion from parliament, said on Saturday he may no longer back the coalition but would not be able to bring it down as a group of MPs in his party pledged support for Prime Minister Enrico Letta.

After Monday's debt exchange, Italy will not offer five-year bonds at its regular end-of-month auction. With its 2013 funding almost completed after a record inflation-linked bond sale at the start of the month, Italian bonds will benefit from reduced supply pressure into year-end.

Elsewhere, euro zone bonds were broadly buoyed by the prospect of more easy monetary policy. Not only did the ECB surprise markets with a rate cut this month, but Janet Yellen's comments at a hearing into her nomination to lead the U.S. central bank were considered dovish.

Bund futures rose 22 ticks to 141.85. Ten-year German yields were 2.4 bps lower at 1.68 percent while other highly-rated bonds were 2 bps lower.

Ten-year Belgian yields fell 4.6 bps to 2.39 percent after Belgium cancelled the final bond auction of this year.

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