* Italy sells 6.5 bln euro of five- and 10-year bonds
* Court to rule on former PM Berlusconi’s tax fraud case
* Ruling may have impact on government stability
By Marius Zaharia and Ana Nicolaci da Costa
LONDON, July 30 (Reuters) - Italian government bonds firmed on Tuesday after a smooth debt auction that defied political uncertainty as a court considered whether former premier Silvio Berlusconi should be jailed.
Italy’s supreme court heard his last appeal against a jail sentence and ban from public office for tax fraud in a case which could threaten the shaky coalition government. Berlusconi’s chief lawyer said it was very unlikely the court would reach a decision on Tuesday.
However, a sale of 6.75 billion euros ($9 billion) of bonds met comfortable demand - 10-year borrowing costs hit their lowest since May. Analysts largely attributed the auction’s success to big peripheral debt repayments.
In secondary markets, 10-year Italian yields were 5 basis points lower on the day at 4.41 percent.
“Italy is doing fairly well given the political turmoil,” DZ Bank strategist Christian Lenk said. “The market is still ignoring the issue in a way because it’s (in its) early stages.”
Some 10 billion euros of Italian bills are due to be repaid on Wednesday and 25 billion euros of bonds mature on Thursday. Italy and Spain pay a combined 16.6 billion euros in coupons this week, according to Reuters data.
With Tuesday’s auction, Italy has completed around 80 percent of its planned 2013 funding, Reuters calculations show. As some two thirds of its debt is owned by domestic investors, who tend to hold the bonds for longer, Italy is in a good position to weather any future political crises.
“If this (the Berlusconi ruling) forced an early set of elections, I think it would be probably negative just from the point of view of market uncertainty but I would buy into that negativity,” Padhraic Garvey, head of investment grade debt strategy at ING said. He added that Italian bonds were already very cheap against Spanish counterparts.
“Spain is a much weaker credit at this point. Italy should be trading 75 basis points through Spain comfortably and that would be a better reflection of where Italy should be.”
The 10-year yield gap between Spanish and Italian bonds last traded at 21 basis points.
Ten-year Italian yields sit within this year’s 3.7-5.1 percent range. Its upper bound was first tested when February’s inconclusive elections left Italy without a government for two months before Prime Minister Enrico Letta’s centre-left PD Party and Berlusconi’s centre-right PDL agreed to share power.
Back then, Italy was riding a wave of global risk appetite, with central banks gushing liquidity. But sentiment could shift against high-yielding assets later this year if the Federal Reserve starts reducing monetary stimulus as planned.
“You could say that when Italy didn’t have a government earlier this year there was little or no market impact so why should it be different now?” said Rabobank rate strategist Lyn Graham-Taylor.
“It is different because (Fed) tapering is just around the corner ... so people will care more this time around. It could have a bigger impact in terms of an increase in Italian yields.”
The Fed, the European Central Bank and the Bank of England hold policy meetings this week, with investors particularly looking for clues to when the Fed would slow its bond purchases.
Traders said euro zone government bonds, and especially benchmark German Bunds, were unlikely to move much before the meetings. Bund futures closed 1 tick lower at 142.45.