September 5, 2018 / 10:37 AM / a month ago

UPDATE 2-Italy's bond yields tumble on hopes of EU-friendly budget

* Di Maio says 2019 budget will keep accounts in order

* Italy’s 10-year bond yield lowest in almost a month

* BTP/Bund spread tightest in almost a month

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates price action, sell off in German bonds)

By Dhara Ranasinghe and Virginia Furness

LONDON, Sept 5 (Reuters) - Italy’s bond yields fell to their lowest in almost a month on Wednesday as the government sought to reassure markets it would respect European Union rules on fiscal discipline in budget talks.

Deputy Prime Minister Luigi Di Maio said on Wednesday the 2019 budget would be “courageous”, but would keep state accounts in order.

Fellow Deputy Prime Minister Matteo Salvini told the newspaper Il Sole 24 Ore that if the government wants to run the country for a long time “we cannot blow up its public accounts.”

Salvini met Di Maio and Prime Minister Giuseppe Conte on Wednesday to discuss the budget, the government’s first major legislation, which has to be issued by mid-October.

Fears that the government, made up of the anti-establishment 5-Star Movement and far-right League, will push for higher spending and worsen the already high debt have battered Italian markets in recent months.

But on Wednesday short- and long-dated Italian bond yields fell more than 10 basis points , making Italy the outperformer in euro zone bond markets.

Italy’s stock market also outperformed most European bourses.

“We’ve had bearish price action all summer, and it now looks like the centre of gravity is shifting towards a fiscally restrained stance in Italy,” said Antoine Bouvet, a rates strategist at Mizuho in London.

Italy’s 10-year bond yield fell to 2.87 percent, its lowest in almost a month, pushing the closely watched spread over benchmark German Bund yields to around 248 bps - its narrowest in nearly a month.

The Italian/German bond yield gap has tightened 30 bps over the past two sessions alone.

Italy’s five-year bond yield fell as much as 20 bps at one point, also hitting near one-month lows at 2.09 percent .

Sources told Reuters on Tuesday that Salvini is pushing for the government to accept a budget deficit “a bit above” 2 percent of gross domestic product next year.

An important question for investors is whether increased budgetary discipline is enough to save Italy from further ratings downgrades, says ING rates strategist Martin van Vliet. Ratings agency Fitch cut Italy’s outlook to negative from stable, although it kept its credit rating at BBB.

“Maybe the deficit target is not sufficient to stop the agencies pulling the trigger,” he said. “If growth slows next year, Italy could be downgraded, leaving aside the deficit. If we have a downgrade by just one notch, that could prompt foreign investors to possibly throw in the towel.”

Outside Italy, most euro zone bond yields rose.

Yields on safe-haven German bonds were also pushed up after a report raised hopes of a breakthrough in talks regarding Britain’s exit from the EU.

Germany’s 10-year bond yield rose around 4 bps to 0.40 percent, its highest in almost a week.

Reporting by Dhara Ranasinghe and Virginia Furness, editing by Larry King and Janet Lawrence

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