February 23, 2018 / 8:30 AM / in 8 months

Italian bonds set for worst week of year as election looms

* Italian 10-year bond yields up 10 bps this week

* Biggest weekly rise of the year as March 4 election looms

* Italian/German bond yield gap widest since late Jan

* ECB’s Coeure to speak later in day

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

By Dhara Ranasinghe

LONDON, Feb 23 (Reuters) - Italy’s 10-year government bond yield was poised on Friday for its biggest weekly rise of the year so far, reflecting growing unease about a looming national election that is expected to result in a hung parliament.

Italian bond markets have proved resilient in the run-up to the March 4 election thanks to a stronger euro zone economy, a recent ratings upgrade, a fall in euro-zone break up risks and a toning down of anti-euro rhetoric from populist parties.

But with the election just over a week away some unease has crept into markets, leading to an underperformance of Italian debt and gains for safe-haven German bonds.

Latest polls point to a hung parliament, where no one party or coalition has an outright majority to form a government, with analysts expecting a period of short-term volatility that could weigh on bond and stock markets.

Italy’s 10-year bond yield was up 1 bps at 2.09 percent . It has risen about 10 basis points this week, set for its biggest weekly rise since late December, according to Tradeweb data.

That has left the gap between Italian bond yields and those of benchmark euro zone issuer Germany at around 140 bps, its widest since late January.

Still, this gap, a gauge of how investors view relative country risks, is not far from where it stood in early February at around 126 bps — which was the tightest in over a year.

“If I just observe bond yield spreads for now, they have compressed, which suggests there is confidence relative to the outcome of the Italian election,” said J Patrick Bradley, senior vice president, investment research at Brandywine Global.

“That is surprising given the uncertainty of the outcome.”

Most euro zone bond yields dipped in early trade, with Germany’s 10-year Bund touching a 2-1/2 week low at 0.68 percent .

Analysts said an Italian sale of inflation-linked bonds and short-dated paper on Friday could attract more attention than usual given the election.

They also noted comments from European Commission President Jean-Claude Juncker this week, who was reported warning about Italian election risks.

“Some long forgotten patterns return to euro bond markets with Bunds rallying while Italy sells off,” said Commerzbank rates strategist Christoph Rieger.

“Juncker’s election warning seems more like an excuse rather than an explanation, but it underscores that markets should become increasingly jittery in coming days when the election grabs more headlines.”

Reporting by Dhara Ranasinghe; Editing by Catherine Evans

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