February 12, 2013 / 12:30 PM / in 5 years

EURO GOVT-Spanish, Italy bonds firm in face of political worries

* Italy, Spanish bonds supported by domestic buying

* Recovery seen short-lived as political concerns persist

* Focus on ECB’s Draghi when he speaks in Spain

By Emelia Sithole-Matarise

LONDON, Feb 12 (Reuters) - Spanish and Italian bonds rose on Tuesday as some domestic buyers took advantage of a recent sell-off, but the recovery could be temporary given political uncertainty in both countries.

Trade in the two periphery nations’ paper has been choppy over the past week as Spanish Prime Minister Mariano Rajoy faces calls to resign over a corruption scandal while in Italy, ex-premier Silvio Berlusconi’s comeback in polls less than two weeks before elections is unsettling investors.

Spanish 10-year yields fell 13 basis points on the day to 5.31 percent, having risen to a seven-week high around 5.55 percent last week as Madrid fought to shake off the scandal, in which Rajoy denies wrongdoing.

“We’ve had some decent buying, mainly domestics in Spain. Our feeling has been that the political crisis in Spain was fairly overblown,” a trader said. “Relative to Italy which still has the election hanging over it, Spain is the more stabler affair,” a trader said.

The spotlight stays on Madrid where European Central Bank President Mario Draghi is due to address Spanish lawmakers later on Tuesday to explain and defend the ECB’s current policy strategy against a backdrop of heightened concerns about the strong euro. Draghi is also expected to meet Rajoy, but the market does not expect them to discuss a potential aid request by Madrid that could trigger the ECB’s bond purchase scheme.

Spanish short-term auction yields were little changed on Tuesday at a sale of 6- and 12-month bills.

Italian bonds rose in tandem with their Spanish equivalents, with 10-year BTP yields down 10 bps on the day at 4.52 percent after the country successfully sold 8.5 billion euros of one-year debt, though at a higher cost.

Italy’s borrowing costs are also expected to rise at a sale of up to 5.25 billion euros of bonds on Wednesday on mounting tensions before the Feb. 24 elections, though redemptions should ensure ample demand.

“There will be some focus on Italian auctions tomorrow to see how that goes as the elections near. Yields have gone up a little bit and that will be reflected in the auctions but we expect them to get the bonds away,” said Lyn Graham-Taylor, a rate strategist at Rabobank.

The rebound in Italian bonds was, however, expected to fizzle out as the elections approach as investors worry that a strong rally in the polls by Berlusconi could result in a fragmented parliament. That could hamper Rome’s ability to push through structural reforms needed to cut the country’s massive 2 trillion euro debt pile.

Those concerns were keeping some investors sidelined from Italian sovereign debt for now.

“We’ve done a bit (of buying) in Italy. But to do more we want to see some clarity coming from Italy on the results of the elections,” said Rose Ouahba, head of fixed income at Carmignac Capital Plus which manages 808 million euros.

“We all know the impact of Berlusconi coming back on the political scene would be damaging for the Italian spread. We did not want to increase our exposure for now. We’re looking more to increase our exposure if we have confirmation that we re not going to have a hung parliament,” she said.

IRISH GAINS

Also reflecting the defensive posture some analysts are adopting on Italy, Unicredit strategists saw scope for further gains in favouring Irish debt, which rallied sharply last week after Ireland concluded a bank debt deal that will reduce its borrowing costs for the next decade.

They moved their ”buy’ stance on Irish 2018 bonds against Italy to a spread target of -50 bps from -30bps.

“The reason for shifting out the target is to let the profit run and be in the position of capturing the current positive momentum as well as a possible overshooting of markets sentiment both in positive terms versus Ireland and in negative terms versus Italy,” they said in a note.

At the euro zone’s core, German Bund futures were last 3 ticks lower on the day at 142.88. The contract has struggled to decisively break above 143.00 for two consecutive sessions which technical analysts say could pave the way to 143.15, the 200-day moving average which would herald further gains.

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