January 11, 2019 / 9:18 AM / in 9 days

Italy auction to act as bellwether as Fed talk keeps rates low

* European yields fall before key Italian sale

* Bond markets focused on Fed, U.S. shutdown, Brexit vote

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

By Virginia Furness

LONDON, Jan 11 (Reuters) - European government bond yields fell on Friday before a key bond sale by Italy and after the U.S. Federal Reserve reiterated its cautious stance on rates.

A recovery in Asian equities overnight did not feed through to a selloff in core rates on Friday and most euro zone bond yields opened around one basis point lower in early trade.

News that trade talks between Washington and Beijing are moving to higher levels lifted European equities but bond market investors remain focused on risks arising from the U.S. shutdown, the UK’s Brexit vote next week as well as impending supply.

“In equities, risk sentiment has improved but this is not really reflected in a sharp sell-off in core rates,” said ING rates strategist Martin van Vliet.

Euro zone government bonds tend to sell off when market sentiment improves, as investors switch from “safe” assets to more risky ones.

But on Friday, a reiteration of the Fed’s dovish stance by Chairman Jerome Powell on Thursday supported rates at the short end.

“If they do pause, it rationalises the fact that hikes have been priced out and keeps rates lower,” said van Vliet.

Powell stressed again that the U.S. central bank can be patient in approving any further rate increases, though he did add that the Fed would continue allowing its nearly $4 trillion portfolio of bonds to shrink each month, to a level “substantially smaller” than it is now.

German government bond yields, the benchmark for the region, fell around one basis point across the curve with the 10-year government bond yield at 0.185 percent, close to two-year lows hit last week.

Other core euro zone bond yields were also 1-2 basis points lower,.

HIGH SUPPLY

Italian auctions are in focus as the country prepares to sell up to 6.5 billion euros of three, seven and 30-year BTPs.

A successful deal “would help lift remaining doubts about Italy’s ability to sell 250 billion euros plus in paper this year,” wrote Societe Generale analysts in a note published on Friday.

Italian government bond yields fell up to three basis points ahead of the sale, outperforming the broader market., .

The Germany/Italy bond yield spread had widened marginally to 269 basis points in early trade..

RATINGS REVIEWS RESUME

Elsewhere, Fitch will publish its review of Spain’s credit rating after market close though analysts do not expect any change to its A- rating, and DBRS will publish its rating on Italy.

Spain’s council of ministers is due to approve its draft budget for 2019. The deficit target is expected to be slashed to 1.3 percent, instead of 1.8 percent. (Reporting by Virginia Furness Editing by Andrew Heavens)

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