March 11, 2013 / 9:26 AM / in 5 years

EURO GOVT-Fitch downgrade hurts resilient Italian bonds

* Italian bonds fall after downgrade, but remain resilient

* German Bunds benefit from Italian backdrop

* Analysts say peripheral optimism overdone

By Ana Nicolaci da Costa

LONDON, March 11 (Reuters) - Italian borrowing costs rose on Monday after a downgrade by Fitch to Italy’s credit rating on Friday dented appetite for its bonds in favour of safe-haven assets.

Fitch lowered Italy’s sovereign rating by one notch to BBB-plus, with a negative outlook, raising the risk its next ratings change will be a further downgrade.

The move was based on political uncertainty after recent elections, a deep recession and mounting debt.

Markets have shown more resilience than expected to a political deadlock in Italy, but the downgrade could add to Italy’s woes as it seeks to raise funds later this week.

Ten-year Italian government bond yields rose 7.4 basis points to 4.67 percent, while BTP futures were down 59 ticks on the day to 108.78.

German Bund futures were up 31 ticks on the day at 142.77, but were little changed from after-hour trading levels hit on Friday.

“They (Fitch) are only playing catch up with the others,” one trader said, referring to the fact that Standard & Poor’s already rates Italy BBB-plus, with a negative outlook.

“But we remain negative on Italy. We still think the market is too complacent on Italy, so we are still looking for the 10-year yield spread to widen versus Bunds,” the trader added.

The 10-year yield gap between Italian and German bonds was at 315 basis points, 8 basis points wider on the day. The cost of insuring Italian government debt against default rose.

The downgrade could cast a shadow over Italy’s bond auction this week but analysts still expect ample liquidity and yield-hungry investors to support the sale.

“I am sure it will go relatively well,” Cyril Regnat, fixed income strategist at Natixis said.

But he said optimism towards lower-rated debt was overdone.

“The market is probably too optimistic regarding Italy and even more regarding Spain,” he said.

“Italian and Spanish debt are really expensive. We would wait to enter longer positions on both debt - right now, it’s too risky given these uncertainties on the political side.”

Italian and Spanish bonds have continued to benefit from the European Central Bank’s promised but untapped bond-buying program which would serve as a financial backstop for struggling euro zone sovereigns if they asked for help.

Ten-year Spanish government bond yields were down 3 basis points at 4.74 percent - their lowest levels since February 2012, when banks were using cheap ECB loans to buy peripheral debt.

Part of the appetite for riskier assets has also been driven by better U.S. data which is fueling optimism about the global economy.

Data on Friday showed U.S. employers added a greater-than-expected 236,000 workers to their payrolls in February and the jobless rate fell to a four-year low, offering a bright signal on the health of the world’s largest economy. [ID:nLNS8EE92I0 (Editing by Chris Pizzey, London MPG Desk, +44 (0)207 542-4441)

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