By Valentina Za and Emelia Sithole-Matarise
ROME/LONDON Jan 30 Italy's funding costs fell at auction on Thursday, with demand from yield-hungry investors sending returns on its five-year debt to a euro lifetime low as emerging markets tumbled and prices of top-ranked bonds rose.
Large reinvestment flows from maturing debt and coupon payments this week likely fed demand, helping Italy raise 8.46 billion euros ($11.5 billion), near the top of its planned range.
Its benchmark 10-year borrowing costs fell to 3.81 percent from 4.11 percent at a similar auction a month ago, matching a level last seen in August 2010. The five-year bond, a new issue, sold at a record low of 2.43 percent, well below the 2.71 percent it yielded in late December.
This helped stabilise Italian 10-year yields at 3.86 percent, unchanged on the day but outperforming other lower-rated euro zone peers where activity was subdued by the selloff in emerging market currencies.
"Overall a good auction that bears witness to the market's buoyant mood towards Italian paper as better economic fundamentals in the euro zone's periphery help insulate it from volatility on emerging markets," ING strategist Alessandro Giansanti said.
Worries about emerging economies are intensifying after policy moves in Turkey, India and South Africa failed to stem an exodus of capital. The Federal Reserve's decision to withdraw more of its monetary stimulus and weak Chinese data are fueling those concerns.
Analysts said that a higher risk premium on Italian bonds versus German benchmarks is likely to have boosted their appeal too.
"The recent (spread) re-widening both versus Germany and Spain might have been seen as a good buying opportunity for Italian bonds today," Newedge Strategy's Annalisa Piazza said in a note.
The five-year bond in particular attracted healthy demand. Analysts said that good interest came from domestic investors looking to reap higher returns by extending the average life of their portfolios as ultra-easy monetary policy in the euro zone keeps a lid on short-term rates.
Bonds issued by the euro zone's weaker economies, apart from junk-rated Greek and to a lesser extent Portugal, have been largely resilient to the turbulence in emerging markets.
RBS strategist Harvinder Sian said some of the cash flowing out of emerging markets could find a home in Italian, Spanish and Irish bonds, for which sentiment has been bolstered by the European Central Bank's accommodative policy and an improved economic growth outlook.
"The weakness in emerging markets actually favours, on a medium-term flow basis, the euro zone periphery," Sian said.
"The developed markets went into crisis in 2008/09 and investors looked across and found emerging markets more attractive ...That flow is now beginning to reverse back to the periphery."
At the euro zone's core, German 10-year debt yields were down 2.4 bps at their lowest levels in nearly six months around 1.62 percent. Bund futures were 32 ticks higher at 143.21 with traders saying month-end related buying added to the gains.
"Fears of a crisis in emerging markets is supporting Bunds and that's why we saw the Bund auction yesterday doing very well despite some dealers thinking it was very expensive," one trader said. "We saw a big asset allocation into Germany and I think the market got caught a bit short."