January 30, 2012 / 12:05 PM / 7 years ago

UPDATE 2-Italy 10-year bond yields fall, confidence grows

* Sells 7.48 bln euros of bonds

* 10-yr yields 6.08 pct against 6.98 pct at end-Dec. sale

* Fitch cut Italy rating to ‘A-‘ late on Friday

By Valentina Za

MILAN, Jan 30 (Reuters) - Italy’s longer-term borrowing costs fell to just above 6 percent on Monday, their lowest since October, indicating growing investor confidence the government can tackle a daunting refinancing challenge in the next few months.

Although foreign investors are still largely reluctant to take up longer-term Italian bonds, the country’s banks have stepped up purchases of domestic debt largely thanks to the European Central Bank’s disbursement of cheap, three-year loans.

Ten-year yields fell by nearly one percentage point at Monday’s 7.5 billion euro ($9.85 billion) sale, offering evidence that the ECB liquidity boost is spreading to longer maturities after powering a rally at the short end of the curve.

“Foreign exposure has been cut significantly since Italy has come under pressure last summer,” RIA Capital Markets bond strategist Nick Stamenkovic said. “I think domestic investors have taken the largest part with maybe some appetite from overseas investors.”

Analysts said demand could have been stronger when taking into account the nearly 36 billion euros in bond redemptions and coupon payments due on the auction’s settlement date.

“We expected a better show on the demand side because of the coupon and redemption payments in the week, if you take that aside it was an OK auction,” said Achilleas Georgolopoulos, a strategist at Lloyds Bank in London.

“We know now that all of the new auctions will be OK.”

Italian 10-year bonds came under pressure in the market before the auction but stabilised afterwards. Yields last stood at 6.12 percent, up 20 basis points on the day, after breaking below 6 percent last week following strong Italian short-term debt sales.

Traders said the fall in Italian yields was supporting market sentiment, putting an end to sales from abroad.

With some 90 billion euros of bonds maturing between February and April, Italy’s refinancing task seemed almost unmanageable last November, when its yields soared to euro lifetime records highs of nearly 8 percent.

EURO ZONE RISK

That forced a change of government and new Prime Minister Mario Monti has since been striving to regain market confidence. He has engaged the country in broad-ranging austerity and reform efforts to try to keep the world’s fourth-largest debt pile under control.

Considered a proxy for euro zone risk with its 1.9 trillion euro debt, Italy is vulnerable to any worsening of the debt crisis in the area.

“This can last as long as the ECB is providing funding,” Stamenkovic said.

With a new three-year ECB tender scheduled in February, analysts see continued domestic demand for government debt that can be used as collateral to borrow cheaply from the central bank.

“The larger Italian banks have already done their share, we see demand coming now mainly from several smaller Italian lenders or savings banks,” a trader at one primary dealer said asking not to be named.

Monday’s sale came after Fitch Ratings cut Italy’s debt rating by two notches late on Friday to ‘A-‘. It also downgraded four other members of the single currency bloc.

The Treasury, which missed only slightly the top of its targeted range of up to 8 billion euros, paid 6.08 percent to sell 10-year paper on Monday — down from 6.98 percent a month ago.

By comparison, Spain paid 5.4 percent earlier this month on new 10-year debt, down from nearly 7 percent in November. Madrid’s much lower funding needs have helped Spain benefit more from the ECB-driven rally.

However, demand for Italy’s 10-year benchmark totalled 1.4 times the offered amount, above last year’s average bid-to-cover ratio for this bond.

The sale of a new five-year bond saw weaker demand but yields fell sharply anyway. At 5.4 percent, the five-year auction yield was more than a full percentage point below a euro lifetime high of 6.5 percent Italy paid in mid-December.

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