October 2, 2018 / 12:25 PM / 2 months ago

Italy yields hit 4-1/2-year high as lawmaker sparks euro exit fears

LONDON (Reuters) - Italy’s 10-year bond yield soared to 4-1/2 year highs on Tuesday after a lawmaker said that most of the country’s problems would be solved by ditching the euro, although reassuring comments from the government bought some calm to a jittery market.

FILE PHOTO: The Milan's stock exchange building is seen during the opening of the initial public offering of the Poste Italiane in downtown Milan, Italy, October 27, 2015. REUTERS/Alessandro Garofalo

Claudio Borghi, economic head of the League party, on Tuesday clarified that the government had no intention of leaving the euro, dialing back earlier comments on Italy’s membership of the bloc. Prime Minister Giuseppe Conte also said Italy is totally committed to the currency.

In the wake of those comments, Italy’s shorter dated borrowing costs pulled back from four-month highs.

Italy’s two-year bond yield was up six bps at 1.43 percent, comfortably below highs hit earlier in the day at 1.63 percent IT2YT=RR. Five-year yields, which had jumped more than 20 bps earlier in the session, were 9 bps higher in late trade at 2.65 percent IT5YT=RR.

But further out the curve, borrowing costs remained elevated as concerns about the fallout from Italy’s 2019 budget plans lingered.

“The assurances by the politicians that there are no plans to leave the euro have reassured markets,” said ING rates strategist Benjamin Schroeder.

“But at the same time investors want to get a better handle on what the budget means for Italy’s debt sustainability.”

Italy’s 10-year government bond yield IT10YT=RR hit a 4-1/2 year high of 3.44 percent and held close to that level in late trade, last up 14 bps on the day.

That left the gap IT10YT=RR DE10YT=RR between Italian and German yields close to the widest in more than five years at over 300 basis points.

Graphic: Italy/German yield gap widest in over 5 years - reut.rs/2P0x61a

As euro zone officials warned of a return to crisis days, the Italian/Spanish yield gap ES10YT=RR was at its widest over any closing price in the last 20 years.

The Greek/Italian yield gap fell to under 100 basis points, its narrowest since 2009 GR10YT=RR.

Deputy Prime Minister Luigi Di Maio reiterated Italy would not change its budget deficit targets.

“It smells clearly like the crisis days,” said Commerzbank strategist Christoph Rieger, referring to the euro zone debt crisis of 2010-2012, when the breakup of the bloc was a possibility.

Rieger said market sentiment was also hit by comments from the European Commission head Jean-Claude Juncker comparing Italy with Greece.

Graphic: Fresh "Quitaly" fears bond, euro selloff - reut.rs/2P21how

ITALIAN BANKS, EURO HIT

The euro briefly fell to a six-week low at $1.1505 EUR= after Borghi's comment.

Shares in Italian banks .FTIT8300, whose government bond holdings make them sensitive to political developments, fell as much as 3.9 percent to their lowest in 19 months on fears a bond sell-off would cut their capital ratios, raise their funding costs and hamper efforts to cut bad loans.

The bank index was last down 0.7 percent, having erased a bulk of its earlier losses. Shares in Italy’s largest lenders Intesa Sanpaolo (ISP.MI) and UniCredit (CRDI.MI), while lower, were off multi-month lows.

Still, the cost of insuring exposure to Italian sovereign debt and the debt of the country’s largest lenders rose sharply.

The Italian government is to finalize the 2019-2021 budget program later on Tuesday, Di Maio said.

“Neither the EU or Italy is incentivized to compromise it seems, at least in the opening gambit of the talks,” said Patrick O’Donnell, investment manager at Aberdeen Asset Management.

He said Italy’s 10-year borrowing costs could reach four percent by the end of the year.

Outside Italy, euro zone bond yields fell as investors retreated to the safety of better-rated borrowers such as Germany, Netherlands and Austria.

Germany’s 10-year bond yield was last down four bps at 0.43 percent DE10YT=RR, while Spanish and Portuguese bond yields ES10YT=RR PT10YT=RR were little changed - showing no signs of contagion from the Italy bond sell off.

Reporting by Abhinav Ramnarayan, Dhara Ranasinghe and Virginia Furness; Additional reporting by Tommy Wilkes and Danilo Masoni; editing by Matthew Mpoke Bigg

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