November 8, 2018 / 8:37 AM / 7 days ago

'Scary headlines' keep upward pressure on Italian bond yields ahead of EC projections

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

LONDON, Nov 8 (Reuters) - Italy led the move higher in euro zone bond yields on Thursday ahead of key economic projections from the European Commission which are expected to highlight that the country’s 2019 deficit may be much higher than suggested by Italy.

Safe haven assets such as the German Bund also underperformed as risk sentiment remained strong in the wake of the U.S. midterm elections and ahead of the culmination of the U.S. Federal Open Markets Committee meeting.

Italian government bond yields were up to five basis points higher in early trade, pushing its spread over higher-rated Germany out to 290 basis points.

The European Commission will publish its Autumn Forecasts on which a full assessment of Italy’s draft budget proposal will be based.

The forecasts are likely to suggest that the Italian 2019 deficit may be much higher than suggested by the Rome government due to lower growth assumptions, research by Societe Generale showed.

“Slower growth and unspecified measures should lead to much higher deficit figures than the 2.4 percent of GDP projected by the government – potentially above 3 percent,” wrote analysts in Thursday’s note. “The debt path will also be of particular interest.”

Mizuho rates strategist Peter Chatwell warned of a possible sell-off in Italian bonds if the Commission figures do point to a higher deficit as reported in La Repubblica.

“In our model, it doesn’t move fair value much from 300 bps (over Germany) but scary headlines are likely to cause a widening, but then people may buy on the dip,” he said.

Infighting between the Italian coalition government partners may also keep upward pressure on bond yields. The coalition could collapse if no agreement is reached over statute of limitations measures, Deputy Prime Minister Luigi Di Maio was quoted as saying on Thursday.

Societe Generale also notes the risk of higher fiscal deficits in the Commission forecasts than planned by the national governments in both Spain and Portugal.

Spanish 10-year government bond yields rose two basis points to 1.64 percent before retreating to 1.61 percent, while Portugal’s 10-year government bond yield was flat on the day at 1.93 percent.,.

Heavy supply may also keep upward pressure on yields. France, Spain and Ireland are due to sell some 14 billion euros of bonds between them.

RISK-ON AHEAD OF FOMC

Risk appetite in the wake of Tuesday’s midterm election also remained strong, pushing the yield on Germany’s 10-year government bond, the benchmark for the region, to a new two-week high of 0.465 percent.

U.S. 10-year Treasury bond yields hit a one-month high of 3.25 percent on Wednesday and remained close to this level at 3.23 percent..

The U.S. Federal Reserve began its policy meeting on Wednesday facing a shifting political landscape but little in recent economic data to alter plans for an interest rate increase in December and more to come next year.

Reporting by Virginia Furness Editing by Gareth Jones

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