November 6, 2018 / 12:21 PM / 11 days ago

UPDATE 2-Italian bond yields rise as EU sanctions threat over budget weighs

* Italian govt bond yields up 6-10 bps

* EU raises threat of sanctions

* Focus turns to US midterm elections (Updates prices, Adds Dombrovskis comments)

By Virginia Furness

LONDON, Nov 6 (Reuters) - Italian bond yields rose on Tuesday after EU officials raised the threat of sanctions against Italy if Rome did not change its contentious budget plans, while broader euro zone debt markets hardly budged as key U.S. midterm elections got underway.

Valdis Dombrovskis, Vice President of the European Commission for the euro, said on Tuesday the EU executive was considering sanctions proceedings against Italy if Rome did not change its budget by Nov. 13.

The Commission could impose sanctions as a last resort, but Brussels wants to avoid that option, Pierre Moscovici, the EU’s economics commissioner said earlier on Tuesday.

That followed Monday’s Eurogroup meeting which did little to ease the standoff between Rome and the European Union, and reignited concerns that Italy’s expansionary 2019 budget was a threat to the euro system.

Italian yields were up 4-7 basis points on the day , underperforming other euro zone debt markets.

Still, the scale of the selloff was small compared with recent heavy selling of Italian bonds. Analysts put this down to a lack of any new information and a belief that Brussels would not fine Italy for its breach of EU fiscal rules.

“Twenty-five countries have entered into the excessive deficit procedure and no-one has ever got a fine, so my gut feeling is that they (Italy) won’t get one, just a slap on the wrist,” said Rabobank strategist Lyn Graham-Taylor.

The Commission rejected an earlier budget draft because it envisages an increase in Italy’s structural deficit equal to 0.6 percent of GDP next year, rather than the reduction required by EU rules.

In late trade, Italy’s 10-year bond yield was up 7 bps at 3.4 percent, while the gap over German Bund yields was at 295 bps — up from 289 bps late Monday but holding below the key 300 bps barrier..

ING rates strategist Benjamin Schroeder said Italian bond prices were supported by speculation that the European Central Bank would offer cheap loans to banks under its targeted longer-term refinancing operations (TLTROs).

Elsewhere, most euro zone bond yields were largely steady to one basis point higher, with focus turning to U.S. elections.

Germany’s benchmark 10-year bond yield was 1 bps higher on the day at 0.43 percent.

Opinion polls suggest the Democrats are likely to take control of the U.S. House of Representatives, while Republicans should hold their Senate majority.

“There is some uncertainty premium baked into the market as if Trump’s ability to implement legislation is curtailed, there could be waning fiscal stimulus, and higher risk of a government shut down, so some sort of mild risk off could be argued,” said ING’s Schroeder.

Reporting by Virginia Furness, Editing by David Stamp and Ed Osmond

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