* Italian bond yields fall for second day running
* ECB meeting seen as key to appetite for German debt
* German auction demand to hinge on ECB policy outlook
By William James
LONDON, March 6 Italian government bond yields
fell on Wednesday as investors put their faith in the European
Central Bank's ability to prevent indecisive elections driving
Italy into full-blown crisis.
Investors bought back Rome's bonds for a second consecutive
session despite expectations that attempts to form a coalition
will fail, and with the country's president considering
appointing a technocrat government.
Ten-year Italian bond yields were down 8 basis
points at 4.66 percent as analysts pointed to the ECB's
long-standing, but untested, promise to backstop struggling
sovereigns by buying government bonds.
The moves have been supported by a broadly more optimistic
mood around the global economy thanks to signals from the United
States, as well as expectations of another strong message from
the ECB on Thursday on its determination to see out the crisis.
"At the moment the market is looking through everything and
saying 'Italy is not going to be allowed to leave the euro zone
and it's got too much debt to be allowed to default, so actually
this is quite a nice yielding asset," said Lyn Graham-Taylor,
strategist at Rabobank in London.
The demand for higher-yielding assets tipped Bund futures
, the euro zone's safe haven of choice, 16 ticks lower
on the day to 144.87.
The near-term outlook for core debt was dominated by
Thursday's ECB meeting, at which dealers expect the central bank
to hint at an accommodative policy outlook.
"We think they'll show they had a serious discussion on
rates and with the new round of staff forecasts they may just
pave the way for a cut," a trader said.
But, while that may encourage bonds broadly to rally in
anticipation of lower rates, in the short-term it may help keep
investors in the mood to buy the euro zone's riskier debt in
favour to Bunds.
"At the moment risk assets seem to take central bank
dovishness on board more than bonds do," the trader said.
A German sale of five-year bonds later in the session was
expected to see lower borrowing costs than a month ago,
reflecting investors' increased desire to hold low risk and
highly liquid assets to protect themselves from market
However, with five year bonds looking expensive relative to
other maturities the strength of demand at the sale will also
hinge on how likely the market believes an ECB rate cut is.
"It's a bet on tomorrow's rate decision. If you believe that
tomorrow the ECB will cut rates then the five-year (bond) is not
that expensive. If don't believe that, it doesn't make sense to
go for it," said Patrick Jacq, strategist at BNP Paribas.
Nevertheless, any weakness in core debt was likely to be
constrained by the unanswered questions over when and how Italy
will resolve its indecisive election.
"The cloud of the Italian political situation is unlikely
lift any time soon, which suggests any respite in the
flight-to-quality move could be short lived if the lack of news
extends for a few more days," said Credit Agricole strategist
Orlando Green in a note to clients.