* Tria backing boosts hopes he will stay on in government
* Italian yields down by as much as 18 bps
* Italy/Germany yield spread tightens to 296 bps
* Euro zone periphery govt bond yields - tmsnrt.rs/2ii2Bqr (Updates pricing, adds detail on Portugal and Spain)
By Abhinav Ramnarayan and Virginia Furness
LONDON, Oct 16 (Reuters) - Italian government bond yields dropped across the board on Tuesday, narrowing the spread over German peers, after comments from Economy Minister Giovanni Tria defending the 2019 budget boosted hopes he would remain in the turbulent government.
The expansionary budget, which was officially approved on Monday, sets up a showdown with Brussels because the plan accommodates the big spending and tax cutting ambitions of the coalition partners.
Italian Prime Minister Giuseppe Conte said on Tuesday he was proud of the budget, adding that austerity is no longer a path Italy can follow.
However, much of the concern over the sharply higher deficit was already priced in, so investors focused instead on the comments from Tria, an economics professor who is not affiliated to either ruling party.
Tria said he was confident he could explain to the European Commission that Italy needed to raise spending to offset a slowing economy and described the 2.4 percent deficit target as “normal”. Investors see Tria as a moderating influence in the government.
Italian yields fell as much as 18 basis points, with two-year yields down 18 bps at a one-week low of 1.58 percent and 10-year yields dropping 11 bps to 3.45 percent.
The Italy/Germany 10-year yield spread tightened by about 7 basis points to 295 bps, moving further away from a five-year peak of around 315 bps hit last week.
Italian stocks also performed well on Tuesday, with the FTSE MIB up about 2.2 percent.
Alessandro Balsotti, fund manager at JCI Capital, said that some of the positive sentiment comes from the different factions within the government being able to compromise and agree on the budget.
“Pending more details and reactions from Europe, the market may take the coalition’s ability to reach a compromise as positive,” he said.
But Marchel Alexandrovich, European financial economist at Jefferies in London, warned that the “relative calm” seen in the market could be short-lived, with credit rating reviews and third-quarter GDP data due at the end of the month.
“They have managed to get through to the stage where they have agreed on the proposals and so the budget now goes to Brussels, and it will most likely be rejected, but it’s not in the EU’s interests to pick a fight with Italy,” he said.
Analysts attributed the drop in Italian yields partly to more attractive valuations and partly to a general improvement in risk sentiment, with world markets calming a touch after the wild swings of last week.
Improved risk appetite also helped to lift peripheral bond prices. Spanish and Portuguese bond yields — which move inversely to price — were lower on the day after the presentation of their respective budgets to the EU.
Portugal’s 10-year government bond yield was down seven basis points at 1.94 percent and Spain fell by 4 bps to 1.67 percent.
“The market has viewed as reasonably positive the budget deficit plans of Portugal and Spain, though Spain’s is somewhat clouded by ECB comments that its economy may have peaked,” said Matt Cairns, rates strategist at Rabobank.
Spain’s economic recovery may have peaked and downside risks have materialised, the European Central Bank’s vice-president said on Monday, hours after the Spanish government cut its growth forecast for this year and next.
Portugal’s credit rating was lifted to investment grade by ratings agency Moody’s on Friday.
Germany’s 10-year yield was about 2 basis points lower after monthly data showed economic sentiment among investors has deteriorated in October.
The euro zone benchmark was steady at 0.49 percent, hovering above the two-week lows of 0.478 percent hit on Monday.
Elsewhere, Finland raised 1 billion euros ($1.16 billion) with a tap of existing government bonds maturing in 2028. ($1 = 0.8630 euros)
Reporting by Abhinav Ramnarayan; additional reporting by Danilo Masoni in MILAN; Editing by David Stamp and David Goodman