* Premier Enrico Etta to meet president on political crisis
* Italy 10-year yields at 3-month highs at auction
* Italy 10-year yields inch back above Spanish equivalents
* Bund futures rally on Italy woes, U.S. debt cliff-hanger
By Emelia Sithole-Matarise
LONDON, Sept 27 Italian yields and default
insurance costs rose on Friday as resurgent political tensions
in Rome hurt investor demand for bonds issued by the euro zone's
third largest economy.
Rome's 10-year borrowing costs rose to their highest in
three months at an auction of 6 billion euros ($8 billion) of
bonds. Demand as measured by bid/cover was 1.4 for the 10-year
bond compared with 1.5 at the end of August.
Italian bonds are under strain from renewed threats by
Silvio Berlusconi's centre-right party 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 standoff over
Berlusconi's conviction for 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
Italian bonds underperformed other euro zone debt after the
auction, with its 10-year yields rising 7 basis
points to trade back above Spanish ones at 4.41 percent. Spanish
equivalents were 4 bps up at 4.38 percent.
"We thought there might be better domestic buying but the
coincidence of political uncertainty and that it's quarter end
generally limits banks' ability to take down large commissions.
That combined to get a weak auction," a trader said.
"There's some selling coming through now and Italian bonds
are going to remain weak until we get some clarity on the
political situation," he added.
The premium paid by 10-year Italian debt over German
benchmarks rose 11 bps to its highest in nearly a
month at 267 bps. The cost of insuring Italian debt against
default was up 4 bps at 250 bps, the highest since July 23,
according to data provider Markit.
The flare-up of political tensions is reinforcing investor
doubts about Italy's ability to pursue fiscal reforms, after
Letta's government was forced by the centre-right party to climb
down on a property tax last month.
"What's worrying people is the fact that the rating agencies
have linked Italy's rating to their ability to pass financial
reforms and if ... they start to suspect the Italian government
is incapable of passing the necessary financial reforms then a
downgrade could be in the offing," the trader said.
These concerns are seen driving Italian yields further above
Spanish ones in coming days.
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 increased uncertainty surrounding the current
government and the risk of a potential stalemate that it could
entail do not seem to be priced in by the markets yet,
notwithstanding the significant underperformance of BTPs," said
Sunrise Brokers hed of fixed income research Gianluca Ziglio.
The softer tone in lower-rated euro zone debt and riskier
assets spurred demand for safe-haven German Bunds. Bund futures
were 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 also underpinned
Bunds, but investors were refraining from extending positions
before next week's European Central Bank policy meeting and U.S.
non-farm payrolls report.