June 21, 2017 / 11:22 AM / 2 months ago

GRAPHIC-Chaos of coalitions? North euro zone bond yields diverge

LONDON, June 21 (Reuters) - Yields on the euro zone's top-rated government bonds, which once traded in lock-step within a narrow range, are diverging as political pressures prompt investors to differentiate between the debt of some of the bloc's strongest economies.

French and Italian political risks have roiled bond markets this year but, with those risks fading, the focus has shifted north, where several countries have, or are seeking to form, coalition governments.

The Netherlands shares a top triple-A credit rating with Germany, while Austria and Finland are rated one notch lower.

Dutch government bonds have come under particular pressure in recent weeks as talks on forming a coalition have reached no conclusion since an inconclusive election in March.

"We have been highlighting since the start of the year that Dutch coalition talks will be difficult, and there's always the risk of snap elections in the Netherlands looming," said DZ Bank strategist Daniel Lenz.

"Even if we end up having a minority government, it is important to keep an eye on things, it will be very hard to implement any reforms," he said.

The premium investors demand to hold Dutch 10-year bonds rather than German equivalents, which stood at less than 5 basis points as recently as mid-May, is now around 20 bps.

Traditionally, the dispersion of Dutch, Finnish and Austrian 10-year government bond yields has been tight. However, in recent weeks, that has widened out to about 20 bps, its highest level in well over a year.

In fact, discounting a four-day period in April 2016, that range was over 20 basis on a concerted basis only back in 2012.

In Finland, opposition parties this week demanded the government resign, saying on Monday its plan to stay in power after the break-up of one of its coalition partners was a cynical move that did not reflect the voters' will.

In Austria, the far-right Freedom Party (FPO) is riding high in the polls and may well be part of a new government after early elections are held this October.

"Many investors are currently putting political risks to one side going into the summer and after the French and Italian situations calmed, and are looking more at fundamentals," said Lenz. "As the elections approach, we could see it rise to the fore again."

Reporting by Abhinav Ramnarayan

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