June 13, 2018 / 7:43 AM / 7 days ago

CORRECTED-UPDATE 1-Italian bonds in demand as Italy's Savona calls euro "indispensable"

(Corrects headline to reflect Savona was proposed by League but is an Independent politician)

* EU Affairs Minister Savona says fully backs euro

* Italian borrowing costs drop ahead of key auction

* Key central bank meetings loom in U.S. and euro zone

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, June 13 (Reuters) - Italy’s borrowing costs dropped sharply on Wednesday ahead of a key bond auction after the country’s new EU Affairs Minister Paolo Savona said the euro was “indispensable” and denied he had ever suggested leaving the single currency.

Savona has previously expressed hostile views on the euro, and the 81-year-old’s potential appointment as economy minister for the anti-establishment coalition last month had sparked a market selloff. His appointment was later vetoed.

But in a meeting with foreign press on Tuesday, Savona was at pains to stress he fully backed the euro and did not want to prepare for Italy to quit the single currency.

The comments soothed worries about the euro membership of the bloc’s third largest economy under the stewardship of the 5-Star Movement/League coalition.

“It wouldn’t be surprise for other people in the government to make these comments, but from him it’s significant and quite as random as Trump in his public statements,” said Commerzbank strategist Christoph Rieger.

“Perhaps they are recognising that they can get more out of the EU if they at least commit to certain key principles.”

Italy’s two-year government bond, the asset through which market fears about Italian redenomination and default have largely played out, saw its yield drop well below 1 percent and was last down 14 basis points at 0.90 percent.

This is below where it started the week — at 1.13 percent — and a far cry from last week’s peak of 2.73 percent when the market concerns were at their most intense.

The yield on the benchmark 10-year government bond was 9 bps lower at 2.78 percent, while the closely-watched spread over German yields was at 230 basis points, well below the 268 bps level at the start of the week.

Rieger of Commerbank warned that words alone would not be enough to keep Italian borrowing costs pinned lower in the long term, particularly given the high-spending plans of this coalition government.

“In the longer term they need to do something different to bring the deficit under control, not just pay lip service towards the euro,” he said.

The rally in Italian government bonds came before the country’s debt office embarks on a sale of bonds maturing in three, seven and 30 years.

It is expected to raise 5.25 billion euros from the auction, according to Mizuho analysts.

“If demand for the bonds on offer is simply okay, we would expect there to be another relief rally,” the analysts said in a note.

Other euro zone bond yields were unchanged or slightly lower, with investors hesitating to take any strong views ahead of two key central bank meetings. The U.S. Federal Reserve ends its policy meeting today and the European Central Bank is due to meet on Thursday.

The yield on Germany’s 10-year government bond, the benchmark for the region, was a basis point lower at 0.48 percent. (Reporting by Abhinav Ramnarayan; editing by Sujata Rao and Catherine Evans)

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