* Stability of Italian government put to test
* Italy returns to market this week after summer break
* Bund yields off 1-1/2 year highs before Ifo release
By Marius Zaharia
LONDON, Aug 27 Italian bond yields rose on
Tuesday as tensions within the country's fragile ruling
coalition have grown just as it prepares to return to debt
markets after a summer break.
Disagreement over a housing tax and a looming vote on
whether to expel former premier Silvio Berlusconi from
parliament after he was convicted of tax fraud have raised
worries about the stability of Italy's government.
Prime Minister Enrico Letta has set a deadline of a
government meeting on Wednesday for a deal on the housing tax,
while a Senate committee is due to begin hearing arguments on
Berlusconi's case on Sept. 9.
Italian 10-year bond yields rose 4 basis
points on the day to 4.43 percent, widening the gap over
benchmark German Bund yields to 254 basis points.
"A combination of lingering worries over the ruling
coalition and concession ahead of upcoming supply suggests Italy
will struggle to make any headway near-term," RIA Capital
Markets strategist Nick Stamenkovic said.
Italy will offer up to 3 billion euros of zero-coupon bonds
(CTZ) and up to 1 billion euros of bonds linked to euro zone
inflation on Tuesday, but the real test of sentiment will be a
sale of up to 6 billion of five- and 10-year bonds on Thursday.
Spain's 10-year yields also rose 4 bps on the
day to 4.51 percent, with traders citing profit taking on bets
Spain would outperform Italy after the yield gap between the two
tightened to its narrowest in 1-1/2 years at 8 bps on Monday.
"We saw a strong underperformance of BTPs (Italian bonds)
over Bonos (Spanish bonds) probably on the back of political
tensions in Italy, so the auctions will be very important to
also see the primary market's reaction to that," BNP Paribas
rate strategist Patrick Jacq said.
Bund futures were last 8 ticks higher on the day at
140.13, with cash 10-year German yields a touch
lower at 1.89 percent - just off 1-1/2 year highs of 1.98
percent hit last week.
German yields have risen sharply in recent weeks on
expectations that an improved global economic outlook could
prompt the Federal Reserve to reduce monetary stimulus in
September, while other major central banks might struggle to
keep their promise to keep interest rates low for a long time.
The Ifo business sentiment survey will provide more clues
about the state of the German economy at 0800 GMT.
The Ifo index is expected to rise to 107 in August from
106.2 last month, a Reuters poll showed, but concerns the United
States was inching towards military action against Syria over a
suspected chemical weapons attack gave some support to