July 19, 2018 / 11:30 AM / 5 months ago

UPDATE 2-Italy's short-dated yields fall to over seven-week low as euro fears ease

* Italy PM Conte says euro membership “irreversible” -report

* Italian 2-yr yields drop 8 bps to hit 0.526 pct

* Euro zone borrowing costs drop on carry trade

* France, Spain generate strong demand in bond auctions (Updates prices for close)

By Abhinav Ramnarayan

LONDON, July 19 (Reuters) - Italy’s short-dated government bond yields tumbled to their lowest level in over seven weeks on Thursday, with two analysts citing reported comments from the Italian prime minister in favour of remaining in the euro as a trigger for the move.

The comments came from an interview with Italian daily Il Fatto Quotidiano, where Giuseppe Conte is reported to have said that Italy’s membership of the euro is irreversible.

This was enough to trigger a rally in Italian government bonds, particularly two-year debt, which has born the brunt of worries over the country’s continued membership of the single currency bloc.

“What Conte has been saying adds to what (Finance Minister Giovanni) Tria and even (EU Affairs Minister Paolo) Savona have been saying over the last few days,” said Natixis strategist Cyril Regnat. “All of this is going in the same direction, which is staying in the euro area and ensuring that there’s a commonality between the countries.”

Italy’s two-year bond yield fell almost 10 basis points to 0.523 percent, its lowest in more than seven weeks.

The yield on Italy’s 10-year bond fell to within striking distance of Tuesday’s seven-week low of 2.467 percent before pulling back slightly.

“What we saw in May was the fear of Italy leaving the euro. Now people realise that if you believe what the government says it’s not really about Italy leaving the euro but just changing a few things around,” said Roberto Coronado, portfolio manager at PineBridge Investments.

He said investor concerns have shifted from Italy’s euro membership to government spending and the country’s high debt levels.

“There is still risk in Italy but it’s more of a controlled issue,” said Coronado.

The comments from Conte may have also given investors the incentive to take advantage of the relatively high yields on offer compared to other euro zone debt such as that of Germany.

Analysts says Italy is the subject of “carry trades”, which involve taking advantage of low borrowing costs to invest in a higher-yielding asset.

“There’s a buying opportunity over the next few weeks before the budget talks begin, there’s a bit of carry trade going,” said ING head of rates strategy Padhraic Garvey. “Would you buy Bunds at 35 bps or Italy at 250 bps? Especially if it’s something you can sit on for at least six weeks.”

Italy is not the only country to benefit from this trade. Spain, whose borrowing costs have fallen in recent weeks for the same reason, sold 4.5 billion euros ($5.22 billion) of debt at a quadruple bond auction on Thursday, with yields down from previous sales.

France also drew strong demand for an almost 7.5 billion euro sale of short-dated bonds, enough to cover the deal twice over. ($1 = 0.8616 euros)

Reporting by Abhinav Ramnarayan with additional reporting by Sujata Rao; Editing by Mark Heinrich

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