* 10-yr bond yields at highest since Oct. 2012 at auction
* Italy draws solid demand at sale, market relieved
* Political parties trying struggling to form a government
By Francesca Landini
MILAN, Feb 27 Italy's borrowing costs rose to
their highest in four months on Wednesday at the first bond
auction since this week's inconclusive election but solid demand
from domestic investors eased fears that the political deadlock
could destabilize Europe's second-biggest sovereign debt market.
The level of demand brought some relief to the market after
the extreme volatility seen immediately after an election in
which no party won enough seats to govern.
In a signal of political difficulties to come, comedian and
populist leader Beppe Grillo, who holds the balance of power,
ruled out voting for any government led by the traditional
parties but said his 5-Star Movement could back individual laws.
The Treasury sold the maximum planned amount of 4 billion
euros of the new 10-year bond but the yield it had to offer
jumped to 4.83 percent, the highest since October but still well
short of levels of more than 6 percent seen in June.
"They got it done. The yields are higher than anything
they've done for quite some time but that's hardly a big
surprise," said Elisabeth Afseth, a rate strategist at Investec.
Yields in the secondary market were, however, a little
easier than on Tuesday, when financial markets across the globe
fell sharply after an election which left no party with enough
support to form a parliamentary majority.
There were signs that foreign investors stayed away from the
auction because of the political uncertainty, leaving Italian
institutions to buy up most of the paper.
"Demand for both lines was relatively solid, probably led by
domestic accounts which took advantage of higher yields," wrote
Newedge strategist Annalisa Piazza.
"It's clear that foreign accounts played no major role at
today's auction as the political risk remains high."
The bid-to-cover ratio was a healthy 1.65 - bids totalled
6.6 billion euros - and Italian debt prices and European stocks
briefly rose on Wednesday after the results, with investors
relieved that the sale had gone smoothly.
Rome's 10-year yields in the secondary market
fell 7 basis points to 4.83 percent having reached almost five
percent in the morning ahead of the sale.
Even at this level, however was well down on the 6.19
percent in June, before the European Central Bank's pledge to
buy government bonds of weaker euro zone countries, which
defused the euro zone debt crisis at the time.
Italy also issued 2.5 billion euros of a five-year bond on
Wednesday, paying a yield of 3.59 percent, up from 2.94 percent
one month ago.
An auction of six-month bills on Tuesday also saw yields on
short-term debt rise sharply compared with the previous sale.
The Italian Treasury had taken advantage of a benign market
environment at the beginning of this year to cover more than 20
percent of its total 2013 refunding needs estimated at 420
In the case of a protracted political stalemate, however,
Italian banks would have to continue absorb the largest part of
the country's debt, with foreign investors sitting on the fence.
The dramatic surge of Grillo's anti-establishment 5-Star
Movement dominated an election which left the centre-left bloc
with a majority in the lower house but without the numbers to
control the upper chamber.
That left the parties to try to build an alliance between
forces that have so far shared nothing but deep mutual
hostility. The alternative is an early return to the polls.
Pier Luigi Bersani, head of the centre-left Democratic Party
(PD), has the difficult task of trying to agree a "grand
coalition" with conservative former premier Silvio Berlusconi,
the man he blames for ruining Italy, or striking a deal with
Grillo, a completely unknown quantity in conventional politics.
On Wednesday, Grillo said 5-Star would support individual
measures in parliament on merit but would not give a confidence
vote to any government led by traditional parties.
Moody's Investors Service said the outcome of the vote could
be bad for Italy's credit rating because it raises the
possibility of new elections.
Standard & Poor's said policy choices by the next government
would be crucial for Italy's creditworthiness, underlining the
need for a coalition that can agree on new reforms to improve
the country's growth outlook.
The technocrat government headed by Mario Monti pulled Italy
from the brink of a Greek-style financial collapse in November
2011 and triggered a gradual decline in its borrowing costs.
Monti, however, struggled to pass the kind of structural
reforms needed to improve competitiveness and lay the
foundations for a return to growth.
The country has been stuck in recession since mid 2011 after
recording average growth of less than 0.3 percent between 2000
and 2010, the third lowest in the world, ahead of only Zimbabwe,
Eritrea and Haiti.