April 26, 2013 / 11:11 AM / 4 years ago

EURO GOVT-Political uncertainty pushes Italian yields higher

* Italy PM designate Letta says needs more time to form govt

* Italian yield rise attracts some buyers

* Bunds rise but gains seen limited before U.S. GDP data

By Marius Zaharia

LONDON, April 26 (Reuters) - Italian bond yields edged up on Friday with investors wary that talks to form a government could be derailed by major differences between the country's centre-left and centre-right political groupings.

Traders played down three sessions of losses this week as profit-taking after a strong rally that pushed 10-year Italian yields to 2-1/2 year lows on Tuesday. They said the longer-term positive trend for Italian and Spanish bonds was intact.

Yields came off their early highs mid-way through the European trading session, evidence that some investors were renewing their bets that Italian yields could fall further in an environment dominated by abundant central bank liquidity

Prime Minister-designate Enrico Letta said early-stage talks to form a government after February's inconclusive election were "encouraging", but added there were problems in reaching a deal with centre-right groups led by Silvio .

He said he would use Friday as "a day to reflect" on his chances of forming a government.

"When ... (Letta) was designated the market was positive about it, believing he will form a government. What we're seeing now is a counter-reaction," said Viola Julien, fixed income analyst at Helaba Landesbank Hessen-Thueringen in Frankfurt.

She too said, however, that the downward trend in Italian yields remained intact.

Italian 10-year yields were last 3 basis points higher at 4.09 percent, having hit a session high of 4.14 percent earlier and 2-1/2 year lows of 3.89 percent on Tuesday.

Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers in London, said the market was still largely expecting Italy to form a government and he expected yields to fall back to 3.90 percent once it does.

Afterwards, yields would be driven by how swiftly it moves to tackle issues such as a complicated electoral law and wider growth boosting reforms.

"There will be a government. How long is it going to last that's a different question. Sooner or later (differences) are going to arise again. The main thing is how much they can do before that," Ziglio said.

BUNDS

The uncertainty in Italy was supportive of German Bunds, traders said, but gains were seen limited before U.S. first-quarter economic growth data due later in the day.

Gross domestic product probably grew at a 3.0 percent annual rate, up from a 0.4 percent pace in the previous three months, according to a Reuters poll.

Bund futures, which usually rise in times of increased market tension, were 18 ticks higher at 146.38. Commerzbank strategists said in a note stronger-than-expected GDP data could push Bunds to 145.75.

Helaba's Julien said weaker-than-expected GDP data could see Bund futures approaching their all-time highs again at 146.89.

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