* Election result seen fuelling deeper sell-off in Italy
* Demand may weaken at Italian debt sale
* Bernanke comments tempering safe-haven flows
By Marius Zaharia
LONDON, Feb 27 Italian bonds steadied on
Wednesday ahead of a major debt auction that is threatened by
worries political deadlock will cripple efforts to reform its
This week's general election produced a hung parliament and
showcased the Italian population's lack of support for budget
cutbacks, raising worries that whatever new government is formed
may be unable to keep its 2 trillion euro debt burden under
The political deadlock could escalate into a new wave of
contagion in the euro zone, seven months after European Central
Bank President Mario Draghi won some respite with his pledge to
do "whatever it takes" to save the euro, analysts say.
The ECB's bond-buying programme (OMT) is still seen as a
force acting against debt costs reaching unsustainable levels.
But it requires countries to first apply for aid and then stick
to an agreed programme of austerity, raising questions about how
soon it could be activated.
"Italy has reminded everyone that triggering the OMT ... is
not as easy as the market thought," said Gilles Moec, economist
at Deutsche Bank. "As it is a reminder of the fragility of the
entire system, it has a negative impact for the risk premium for
the entire periphery."
"Now, is it enough to send us into the kind of mayhem in
which we were last summer? No. It raises the bar for ECB
intervention but it doesn't kill the idea."
Italian 10-year bond yields were steady at
4.90 percent, having risen about half a percentage point this
week. They are still well below last July's highs of about 6.7
Spanish, Portuguese and Irish yields, which have been
dragged up by Italy this week, were also stable on Wednesday.
The longer it takes for Italy to form a government, the
higher the chances of a bigger sell-off, analysts say.
Near-term, however, the direction depends on how well an auction
of up to 6.5 billion euro worth of 5- and 10-year debt is
Yields are expected to rise sharply and demand is expected
to be weaker than at previous sales, mirroring the outcome of a
T-bill auction on Tuesday.
"Supply will be the main focus and ... it could be a bit of
a problem," one trader said, adding that he expected Italian
10-year yields to eventually rise above Spain's, which last
traded at 5.35 percent.
On the other hand, the possibility that the sale could go
smoothly kept other parts of the market wary that peripheral
markets could enjoy some relief.
"Provided the auctions are carried out without any major
digestion problems, as we expect, this could offer some brief
respite from the current risk averse environment," Credit
Agricole strategists said in a note.
Safe haven German Bunds were stable as U.S. Federal Reserve
Chairman Ben Bernanke's defence of the central bank's stimulus
programme eased some of the past week's concerns over the
outlook for global growth.
Bund futures were last 2 ticks higher on the day at
144.92, having rallied 128 ticks in the previous two sessions.