July 3, 2018 / 11:08 AM / 5 months ago

UPDATE 2-Italy's bond yield gap with Germany narrows as Merkel hangs on

* Italy/German spread tightest in almost 2 weeks at 228 bps

* Threat of German government collapse recedes

* Trade war threat still hangs over market

* French 30-year yield hits 18 month low

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices for close)

By Abhinav Ramnarayan

LONDON, July 3 (Reuters) - The gap between Italian and German government bond yields was at its tightest in almost two weeks on Tuesday as worries about a possible collapse of the Berlin government eased, but the moves were muted as trade war concerns hung over the market.

German conservatives settled a row over migration late on Monday that had threatened to topple Chancellor Angela Merkel’s coalition.

The news encouraged investors to shed safe-haven German Bunds and instead buy Italian government debt, reducing the closely-watched spread between the 10-year bond yields of the two countries by 7 basis points to its narrowest in almost two weeks at around 228 basis points.

The trend intensified after Italy’s new economy minister said he planned to ensure the country’s structural balance did not worsen and that Italy’s public debt comes down.

“If politics is going to be less of a threat during the summer holiday season, you can make the case for being invested in peripheral markets because of the higher returns,” said DZ Bank analyst Andy Cossor.

Cossor warned that other risks remain, particularly when Italy’s new anti-establishment government, which has high spending plans, begins discussions with the European Union over next year’s budget.

In addition, the possibility of a full trade conflict between the United States and Germany is keeping major government bond yields pinned near recent lows.

German 10-year bond yields briefly rose 2 bps to 0.32 percent on Tuesday before falling back to trade about 1 bps lower at 0.29 percent.

Other major euro zone bond yields nudged down in late trade while Italian bond yields ceded earlier falls.

Those moves in European bond markets coincided with a fall in U.S. Treasury yields.

LONG-DATED BID

Long-dated euro zone government bonds were in demand after a Reuters report that the ECB is considering buying more longer-term debt from next year.

On Tuesday, French 30-year yields dropped to an 18-month low of 1.50 percent. Other long-dated bond yields were higher on the day but not far from recent lows.

“The value in the very long-end of the French curve, relative to Germany, is only just beginning to be realised by investors,” Mizuho’s head of rates strategy Peter Chatwell said in a note.

Elsewhere, Portugal released its quarterly debt issuance plan, which envisages no syndicated bond deals.

Reporting by Abhinav Ramnarayan; editing by Andrew Roche

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