By Marius Zaharia
LONDON Oct 2 Italian bonds firmed on Wednesday on expectations Prime Minister Enrico Letta will survive a possible confidence vote after senior centre-right figures showed support for his coalition.
Italian debt outperformed other euro zone bonds, which were broadly steady before a European Central Bank meeting later in the day. The first U.S. government shutdown in 17 years was still having little impact as many in markets viewed it as only temporary.
Tension rose in Italy after five ministers from former premier Silvio Berlusconi's party resigned at the weekend. The media tycoon's allies have threatened to bring down the government down if he is evicted from parliament following a tax fraud conviction.
But divisions within Berlusconi's People of Freedom party widened sharply this week, easing concern Italy could face a fresh round of potentially inconclusive elections.
Sources in Letta's centre-left Democratic Party said late on Tuesday he had not yet decided whether to call a formal vote of confidence in parliament after a frantic round of meetings.
"People in general expect the Italian government to survive," Nordea chief analyst Anders Svendsen said.
"Maybe Berlusconi pushed it too far this time and ... after all this we could have a more stable government than the one we had before. Italy may come out stronger."
Italian 10-year bond yields fell 6 basis points to 4.41 percent, reversing a recent rise which took them over 4.70 percent. Not all Italian assets rallied, however. Stocks dipped after hefty gains on Tuesday which took them close to two-year highs.
Some analysts remained concerned about the longer-term outlook for Italy, expressing doubts the left-right coalition can implement the reforms needed for the country to contribute to a nascent euro zone economic recovery.
"A lame duck administration still needs to prove itself capable of deep reform," said Societe Generale rate strategist Ciaran O'Hagan. "That is a much tougher task than winning a confidence vote."
German Bund futures were 11 ticks up at 140.37, with little movement expected before the ECB meeting.
While the ECB is not expected to make any changes in its monetary policy, investors will be looking for any new hints on whether it could offer new long-term unlimited loans to banks (LTROs) to keep liquidity ample and short-term rates low.
"I think they'll leave the door open for new LTROs but I don't think he'll signal anything imminent and that's probably the market view as well," a trader said.