January 30, 2013 / 5:41 PM / in 5 years

EURO GOVT-Italy yields rise as market struggles to digest supply

* Italy, Germany see strong debt auctions
    * Yields rise as Italy supply hard to digest
    * Bund selloff resumes as banks' health seen improving

    By Marius Zaharia
    LONDON, Jan 30 (Reuters) - Italian bond yields rose on
Wednesday as the market struggled to absorb the large volume of
debt sold by the country this week, even though demand for the
new paper has looked strong. 
    Solid auctions earlier this month had generally added
momentum to a six-month rally in Italian debt and the shift in
market behaviour seen after a sale on Wednesday could signal a 
pause for the fall in yields, some analysts said.
    Worries that Feb. 24-25 elections could result in a
fragmented Italian parliament that may make it hard for the
government to push through structural reforms might also rein in
cash-rich investors who have raced for returns. 
    "Rates have fallen a lot in Italy and we're at levels  where
... it's difficult to make progress," said Padhraic Garvey, head
of investment grade strategy at ING.
    "Italian rates couldn't fall forever .... We've got
elections coming up and there's a couple of uncertainties out
there and there's a fabulous rally behind us so we're entering a
bit of stability in terms of spreads."
    Ten-year Italian yields rose 11 basis points
to 4.28 percent, having fallen more than two points in the past
six months. They have been stuck in a 4.15-4.35 percent range
over the past two weeks, signalling buyers were struggling to
dominate the market at these levels.
    Italy sold 6.5 billion euros of five- and 10-year bonds on
Wednesday. On Monday, it sold 6.6 billion euros of zero-coupon
two-year bonds and inflation-linked paper. Such a large amount
in a short period of time caused some indigestion, but there was
no indication that a sell-off could occur anytime soon.
    Borrowing costs were the lowest since late 2010 and the
amounts sold met the higher end of the target range.
    Commerzbank rate strategist Rainer Guntermann recommended
investors favour longer-dated Italian debt over shorter-dated
bonds on the view that the search for high yields would keep
investors "open-minded" about peripheral bonds.
    Similar to Italy, Germany had a solid debt auction on
Wednesday, but its bonds weakened in secondary markets. 
    Analysts attributed the strong demand at a 30-year bond sale
to institutional investors needing to match long-term pension
and insurance liabilities to secure assets. In secondary
markets, yields rose as investors felt more confident the
European financial system was healing.
    Demand for three-month funds at the European Central Bank's
unlimited cash tender on Wednesday was only 3.7 billion euros,
much less than expected, meaning banks did not feel the need to
replace three-year loans with shorter-term ones.
    Last week, the ECB said banks will repay 137 billion euros
in three-year loans that the central bank used to avert a credit
crunch in late 2011 and early 2012, causing a sell-off in Bunds.
    "There is a gradual trickle of better sentiment in the real
economy coming from the continued improvement in financial
market sentiment and that should be consistent with a continued
rise in Bund yields," said Chris Scicluna, head of economic
research at Daiwa Capital Markets.
    "Certainly at the shorter-end, if you think that the refi
rate at the ECB is 0.75 percent and five-year yields are only
just around that, it suggests there's further to go."
    Ten-year Bund yields rose 2.8 bps to 1.718
percent. Two-year yields were up 2.2 bps at 0.29 percent.
    With the supply out of the way, investor attention will fall
on the outcome of the Federal Reserve policy meeting which comes
after the European market close. 
    The Fed is expected to maintain asset buying at $85 billion
a month and retain a commitment to hold interest rates near zero
until the unemployment rate falls to 6.5 percent, provided
inflation does not threaten to breach 2.5 percent.
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