* Fiscal slippage concerns dominate investor concerns
* Italian debt offers some of highest yields in low volume market
* Euro zone periphery government bond yields tmsnrt.rs/2ii2Bqr
By Saikat Chatterjee
LONDON, May 14 (Reuters) - Italian bond yields held below recent six-week highs on Monday as investors awaited the outcome of talks between the anti-establishment 5-Star Movement and the far-right League to form a government that is expected to lead to fiscal slippage.
Both parties spent the weekend locked in talks to forge a common policy programme and called the head of state on Sunday to report on their progress towards naming a prime minister.
Though this particular combination was initially greeted as the worst case outcome for Italian markets before a general election, sentiment has since become a bit more optimistic due to an improving economy and the European Central Bank operating with an exceptionally loose monetary policy.
“Markets are showing no signs of nervousness with investors focused on the fiscal policies with the presence of the ECB’s bond purchases offering a potentially big backstop as well,” said Jason Simpson, a rates strategist at Societe Generale in London.
Some of the policies being hawked by the Italian coalition taking shape as the next government include slashing taxes for companies and individuals, boosting welfare provision, cancelling a scheduled increase in sales tax and dismantling a 2011 pension reform which sharply raised the retirement age.
That is expected to increase the fiscal deficit from an estimate of 1.6 percent of GDP this year from 2.4 percent in 2017 though investors waited for details.
Italy’s FTSE MIB is one of the best-performing equity indices worldwide year-to-date as the market focuses on a stronger economy and, despite hitting a six-week high last week, 10-year Italian debt remained a third below a eurozone-debt crisis peak of 7.32 percent hit in November 2011.
Some analysts such as Nomura believe that most investors have held on to their Italian bond holdings despite the growing concerns of fiscal loosening from the new government, as Italian debt offers some of the highest yields in the European investment grade space in a low-volatility environment. Lack of any supply this week is also expected to boost support for bonds.
Germany, France and Spain are entering the bond market this week with fresh issuance though proceeds from redemption of maturing debt is expected to comfortably take care of the supplies, according to Thomson Reuters and Mizuho data.
Risk appetite was broadly firm across the board pushing yields slightly higher with German 10-year yields up 2 basis points on the day at 0.58 percent.
Elsewhere, spreads between two-year U.S. and German debt held below a 29-year high of nearly 312 basis points hit on Friday.
Reporting by Saikat Chatterjee; Editing by Jon Boyle