August 6, 2018 / 11:18 AM / 10 months ago

UPDATE 2-Italy 2-yr yields hold below 1 pct despite Di Maio comments

* Italian officials agree budget outline

* But raise questions on commitment to fiscal discipline

* Italian 2-yr bond yields end around 0.99 pct

* German industrial orders plunge, capping rise in yields

* Euro zone periphery govt bond yields (Updates pricing, reflects market move)

By Abhinav Ramnarayan

LONDON, Aug 6 (Reuters) - Italian two-year borrowing costs dropped below one percent on Monday as investors hunted for yield, though some of the bullishness was tempered by government officials’ comments that renewed fears about their commitment to fiscal discipline.

Last week’s announcement by Prime Minister Giuseppe Conte on a 2019 budget framework brought bond investors flocking back to Italy, the only short-dated euro zone securities offering relatively high yields.

Conte said on Friday the government had fixed the 2019 framework, soothing nerves over tensions within the Italian government and over the future of pro-European Economy Minister Giovanni Tria.

That fuelled a fall in yields across the curve, with two-year yields ending Monday around 0.99 percent, having ballooned out to as much as 1.36 percent before Friday’s budget meeting. Yields fell as low as 0.93 percent at one point .

Moves in longer five- and 10-year maturities were more muted, however, with yields ending roughly unchanged and reversing some of their earlier declines.

Some of the earlier optimism was tempered by Deputy Prime Minister Luigi Di Maio, who said fiscal rules would be applied only if they did not hamper the government’s reform agenda.

Di Maio’s comments threw into doubt the ruling coalition’s commitment to the European Union’s 3 percent public deficit limit.

BBVA rates strategist Jaime Costero Denche described the headlines as not “helpful”.

“Especially the comments that fiscal discipline is not the priority of the programme,” he said. “I feel (the rally) is short term relief, because the market continues to be exposed to fiscal risks. We cannot claim victory.”

Many investors have little choice but to buy Italian two-year debt despite risks, ING rates strategist Martin van Vliet said, noting that some of his clients such as pension funds were under pressure to outperform government bond indices.

“After May, the Italian two-year has become very attractive in terms of yield and many real money accounts who would find it difficult to explain to clients that they are buying longer-dated Italian debt are buying this instead,” van Vliet said.

On May 29, Italian two-year debt had its biggest daily jump in over 25 years on worries the country might quit the euro zone and default on its debt.

In contrast to Italian two-year yields at 0.99 percent, Spanish two-year debt yields minus 0.30 percent and the German equivalent is at minus 0.60 percent. .

Italian shares closed flat on the day, but shares in the country’s third-largest lender Banco BPM fell 7.6 percent after it said earnings missed forecasts due to higher than expected loan loss provisions.

The closely-watched 10-year spread over Germany was at 252 basis points (bps) at the market close, roughly in the middle of the wide 210-285 bps trading range since the end of May.

Euro zone bond yields overall dropped sharply towards the end of last week, not only on Italian politics, but also due to global trade tensions and the effect they may have on the euro zone economy.

Latest data showed German industrial orders fell more than expected in June, posting the steepest monthly drop in nearly a year and a half. That suggests factories in Europe’s largest economy could shift into a lower gear in the coming months.

German 10-year yields dipped to a near one-week low of 0.39 percent, 10 bps below last week’s high.

Reporting by Abhinav Ramnarayan and Virginia Furness; Graphic by Sujata Rao; Editing by Mark Potter

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