Italian bond yields dip as markets warm to Renzi

Thu Feb 13, 2014 12:00pm EST

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By Marius Zaharia and Emelia Sithole-Matarise

LONDON Feb 13 (Reuters) - Italian bond yields dipped on Thursday as some investors saw Matteo Renzi's call for Prime Minister Enrico Letta to resign as paving the way for more decisive government under the centre-left leader.

There was also a widespread belief among market participants that any leadership change will avoid triggering early elections with potentially inconclusive results.

Renzi told his Democratic Party on Thursday that Italy needs a new government. He acknowledged that launching a new government in the current parliament "presents risks", but said "a new phase must be opened."

Letta has been criticised for the slow pace of reforms, with Italy lagging the economic rebound seen in peripheral peers Spain, Portugal and Ireland. Some market participants see Renzi as a leader who could improve Italy's growth prospects.

Italian 10-year bond yields were last 1 basis point down on the day at 3.73 percent, having fallen by about 5 bps since Renzi's comments.

"The thought process (of the market) is that should we see Renzi popping up in government this would give that government a boost - we would have a more dynamic man as a prime minister," DZ Bank strategist Christian Lenk.

"Markets probably like the new guy."

It was not yet clear if Letta would step down and how any attempt by Renzi to replace him would unfold. His party has yet to approve his proposal.

Some investors, however, were sensing change was coming.

"We really are at a crossroads," said Sandra Holdsworth, investment manager at Kames Capital which is overweight Italian and Spanish bonds. "Going on as they (Italy) are and not having political reform and therefore not being able to enact any economic reforms ... will be a poor situation to be in.

"It looks like the force within the country, within the political faction, is one of change and we are taking it as reasonably positive."

LOW ELECTION RISK

Analysts also said the risk of the current political shake-up escalating into a leadership vacuum which would require early elections was limited. The government's failure to deliver a promised electoral reform that reduces the risk of having a hung parliament means that none of the major political parties would have any incentive to follow that route.

Renzi himself said the current electoral law does not permit a successful new vote at this point in time.

"Since no one expects new elections imminently, then political events' impact on the markets should be relatively limited," RBS strategists said in a note. "Renzi is highly regarded on both the European level and by the markets. As such, the market takes this as a marginal positive."

They warned that should Renzi take over, he would have to push reforms through the same government that has been reluctant to approve them so far.

But it was not only Renzi's appeal that supported Italian bonds. Investors focusing on the European Central Bank's ultra-easy monetary policy and an improved growth outlook for the euro zone as a whole are looking to pocket the extra yield offered by lower-rated euro zone issuers such as Italy.

The hunger for yield was on show at a sale of 7.5 billion euros ($10 billion) of three-, seven- and 30-year Italian bonds early on Thursday. Rome sold the top planned amount and paid the cheapest three-year debt costs since the launch of the euro.

"We obviously we have a situation that is a bit complicated on the political front but one has to remember that this is something which is very common in Italy," said Rene Defossez, fixed income strategist at Natixis.

"We are still in a (yield) convergence process and we have no reason to expect this process to come to an end."

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