December 17, 2018 / 9:06 AM / 9 months ago

Italian, French bonds diverge as political worries shift from Rome to Paris

* French deficit likely to be 3.2 pct of GDP - PM

* Italian coalition agree revised budget terms

* France/Germany yield gap close to wide levels

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, Dec 17 (Reuters) - The yield gap between Italian bonds and benchmark Germany’s narrowed on Monday as chances of a rapprochement with the European Union grew, but French bonds suffered as “yellow vest” protests rumbled on in Paris over the weekend.

Italy’s coalition government has agreed on the “numbers and contents” of the budget it will propose to Brussels in a bid to avoid disciplinary action over its planned deficit spending next year, a spokeswoman for the ruling League party said on Monday.

In France, Prime Minister Edouard Philippe told the newspaper Les Echos the country’s deficit is likely to overshoot the EU limit of 3 percent of GDP next year to around 3.2 percent.

“The focus is a bit more on France now - investors are waiting for the revision of the French deficit after the spending measures announced by Macron,” said Natixis strategist Cyril Regnat.

French President Emmanuel Macron last week announced tax cuts for pensioners and an increase in the minimum wage, in an effort to quell protests that continued over the weekend.

“The net issuance target for (French) OATs next year is about 195 billion euros. If they have to increase it, then the market reaction would be even more negative,” Regnat said.

French government bond yields rose a basis point to 0.72 percent, pushing the France/Germany 10-year bond yield spread up to 46 bps, near last week’s 1 1/2-year high.

Italian bond yields, on the other hand, fell. The Italy/Germany 10-year yield spread was at 267 basis points early on Monday, two basis points smaller on the day and not far from a 2 1/2-month low reached on Thursday.

What’s particularly notable is that German yields have dropped recently on downbeat growth and inflation expectations. Ten-year yields, at 0.26 percent, are about half what they were two months ago.

However, Regnat of Natixis warned that Italy’s revised budget has to go through a few more stages before receiving EU approval.

“To me it’s more short-term relief at this stage and investors will be reassessing Italian risk in January,” he said.

Other euro zone bond yields were mostly unchanged on Monday ahead of the release of final euro zone inflation numbers, with Reuters poll showing expectations are for a 2 percent rise in consumer prices over November 2017.

A market gauge of long-term euro zone inflation expectations remain close to recent lows at around 1.623 percent. (Reporting by Abhinav Ramnarayan, editing by Larry King)

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