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Italy sees growing market favour after strong bond sale

Investors have looked more favourably on Italian sovereign debt in recent weeks, impressed by a reform push by Prime Minister Mario Monti.

Tony Gentile/Reuters/Tony Gentile/Reuters

A successful bond auction by Italy on Wednesday cut the risk premium the country pays compared to Germany to issue 10-year debt and the head of the Italian debt management office said it could fall by much more by the end of the year.

Investors have looked more favourably on Italian sovereign debt in recent weeks, impressed by a reform push by Prime Minister Mario Monti, in contrast to increasing concern about Mediterranean neighbour Spain, which is struggling to meet deficit pledges.

Italy raised the top planned amount of €6-billion ($7.7-billion) at the sale, paying the lowest three-year yield since October, 2010, thanks to sentiment bolstered by comments from the U.S. Federal Reserve on Tuesday and sustained demand from investors awash with cash from the European Central Bank.

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The results pushed the 10-year yield premium over equivalent German Bunds down to 292 basis points (100 basis points equals one percentage point), from 300 basis points just before the auction. The investor markup for the market benchmark maturity was below three percentage points last week for the first time since September 2011.

Maria Cannata, in charge of managing Italy's €1.9-trillion debt, said on the sidelines of an event in Milan that the 10-year yield premium could shrink further to 200 basis points by the end of the year based on Italy's fundamentals.

Analysts are more cautious but they see Italian debt continuing for now to perform better than Spanish bonds after Madrid unnerved investors by announcing a larger-than-expected deficit for 2011 and agreeing a higher target with Brussels for this year.

A Spanish sale of up to €3.5-billion of bonds on Thursday will offer a chance to assess the relative strength of demand in the two countries.

Italy sold €5-billion of a new three-year bond on Wednesday at an average 2.8-per-cent yield. That compares to the 3.4 per cent it paid on the same maturity in mid-February.

The bid-to-cover ratio, a measure of investor demand, also improved from a month ago to 1.6 from 1.4 times, despite the larger amount sold on Wednesday.

"Very good. Full amount sold, yield levels well below last time, cover solid," said Marc Ostwald, a strategist at Monument Securities in London. "To be selling particularly the three-year at the lowest level since 2010 … it just shows how the ECB's liquidity flood has helped to alleviate a lot of the tensions for the time being."

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Rome also sold €1-billion of an off-the-run 2019 bond.

In another sign of easing market pressure on the euro zone's third-largest economy, the new issue pays a 2.5-per-cent coupon. That compares to a 6-per-cent coupon on a three-year BTP bond Italy launched in late November, when it came close to following Greece, Ireland and Portugal into a scramble for emergency aid that could have become prohibitively expensive for Europe.

At the time. Italy had to pay a record 7.9-per-cent yield to sell the first tranche of the bond.

The ECB's decision to provide banks with unlimited three-year funds and the appointment of a reform-oriented government in Rome have helped buttress market confidence. Many analysts expect the rally in Italian bonds to continue in the short term, albeit at a more moderate pace.

Italy's 2011 budget deficit was less than half that of Spain and the country posted a 1-per-cent surplus when excluding interest payments on its debt pile.

Its government debt now trades at a smaller premium to Germany than that issued by Spain, reversing a trend which had seen Italian yields exceed Spanish ones by as much as two percentage points in late 2011.

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Looking ahead, however, "the fundamental challenges facing Italy and Spain are well documented and are unlikely to move far out of the spotlight," Citibank analysts wrote in a note. "The longer-term macro risks are likely to continue to deter non-domestic investors from engaging in a meaningful way."

Yet Ms. Cannata said that Italian debt had returned to attract interest from foreign "real money," with demand coming chiefly from Britain, France, the Netherlands, Germany and lately Asia. A trip by Mr. Monti to the United States had encouraged scattered purchases from across the ocean, she said.

With an economy in recession and a central bank forecast for a contraction in output of up to 1.5 per cent this year, Italy does not offer a reassuring picture to longer-term investors.

Hopes of improving low economic productivity are pinned on labour market reforms which Mr. Monti's government hopes to agree on with hostile trade unions by the end of next week.

"I still think Italian bonds will continue to outperform Spain but if we see disappointment in labour market reforms then we will see a sharp adjustment," said Nick Stamenkovic, a bond strategist at Ria Capital Markets.

By stepping up bill issuance in the first part of the year to intercept ECB-fuelled domestic appetite for short maturities, Italy cut the average life of its debt to 6.84 years at the end of February from 6.99 years at the end of 2011.

Ms. Cannata said the Treasury would use proceeds from a new 2016 inflation-linked bond aimed at private investors to cut bill issuance in the rest of the year. Ratings agencies look at the relatively long life of Italy's debt as an important source of credit strength.

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