* German debt rallies on as ECB spurs depo rate cut bets
* Italian political flare-up drives peripheral selloff
* Italy off session highs as yield rise brings buyers back
By William James
LONDON, Dec 6 German bonds rallied and two-year
yields hit their lowest in three weeks on Thursday after ECB
President Mario Draghi said the bank had discussed cutting the
rate on short-term deposits below zero.
The European Central bank left interest rates on hold but
grim growth forecasts, sharply downgraded since September, and
signs that a deposit rate cut was still a policy option helped
yields fall across the German yield curve.
Draghi's comments added momentum to a shift into low-risk
assets that had hit Italian bonds hard during the morning
session after domestic political tension undermined the position
of Italy's technocrat Prime Minister Mario Monti.
"What Draghi said reinforced the risk-off environment we'd
seen in the morning after the negative news on Italy," said
Christian Lenk strategist at DZ Bank in Frankfurt.
Two-year German yields, which are most
sensitive on the curve to a shift in monetary policy, sank close
to their record lows, dropping 4.7 basis points to -5 bps.
The March 2013 Bund future, which became the
front-month contract during the session, rallied more than half
a point to 145.72, picking up steam after breaking past
technical resistance at November's peaks to set a new contract
ITALY LEADS SELLOFF
Italian bonds led a broad peripheral selloff after former
Prime Minister Silvio Berlusconi's PDL party walked out on a
Senate confidence vote, ratcheting up the party's opposition to
the incumbent Monti before an election due early next year.
"These kind of hiccups and the weakening of the technocrat
government is clearly affecting market valuations. To a big
extent things are still OK, but that was clearly a reminder that
these types of events are super important," said David Schnautz,
strategist at Commerzbank in New York.
The 10-year Italian yield rose by as much as
17 basis points on the day to a high of 4.63 percent before
coming back to 4.56 percent as the selloff drew more optimistic
buyers back in. Equivalent Spanish yields followed
a similar path and ended the day 4.5 bps higher at 5.47 percent.
Traders said the extent of the selloff had been exaggerated
by speculative investors using the political backdrop as an
excuse to exit profitable positions after a big rally in the
However, the subsequent retracement underscored both the
impaired liquidity in the market and the general positive
outlook on higher-yielding debt supported by the prospect of ECB
"At these levels some buyers return. Our view is still
basically to buy the dips at the short end of the periphery," DZ
Bank's Lenk said. "You still get good bang for the buck there,
so why not use these levels to add to you positions?"
The risk-averse backdrop helped a 3.97 billion euro sale of
French bonds. The Treasury sold at the top of its target range
as investors sought the liquidity and safety of the French
market, even after Moody's downgraded the euro zone's
second-largest economy's credit rating last month.