August 20, 2019 / 10:30 AM / a month ago

UPDATE 2-Investors sell Italian bonds as government looks increasingly fragile

* German govt bond yields down 5 bps on easing expectations

* Italy sells off as Di Maio signals imminent end of govt

* Salvini says Italy needs 50 bln euro budget for 2020 (Adds detail on German 30-year auction)

By Virginia Furness

LONDON, Aug 20 (Reuters) - Italian government bonds lagged the broader market on Tuesday before an address by Prime Minister Giuseppe Conte that could lead to a confidence vote and bring down the Italian government.

Other euro zone bond yields fell back towards record lows as markets remained focused on the prospect of fiscal stimulus in Germany and monetary easing by the European Central Bank.

Investors in Italian bonds have been on tenterhooks since the leader of the League, Matteo Salvini, called for an end to his party’s coalition government with the 5-Star Movement on Aug. 8.

5-Star head Luigi Di Maio signalled the imminent demise of the government on Tuesday with a Facebook post thanking Conte.

Salvini also renewed concerns that state spending will further strain Italy’s finances, and in turn its relationship with the European Union. He said on Tuesday a budget of 50 billion euros ($55 billion) will be needed for 2020 to bring about a “shock” fiscal stimulus.

How the situation will be resolved is unclear. Possible outcomes include a new government that would push the League into opposition.

Ten-year Italian bond yields were up 4.5 basis points at 1.48%. The spread over top-rated Germany was 215 bps .

A big test of demand for longer-dated paper will come on Wednesday when Germany sells its first 30-year bond via auction with a zero percent coupon, meaning it will have a negative yield.

Hopes for additional stimulus from Germany are growing after reports that the government is prepared to increase fiscal spending, while the People’s Bank of China took steps to lower corporate borrowing costs.

The ECB’s Governing Council is determined to act if the medium-term inflation outlook continues to fall short of its target of close to but below 2%, Finnish central bank governor Olli Rehn said on Monday.

Australia’s central bank also discussed unconventional monetary policy at its August board meeting, leaving the door open for further easing. It has already cut rates twice, to 1%.

Minutes of the bank’s Aug. 6 meeting showed it would consider further rate cuts if they were needed to support growth and achieve its 2% to 3% inflation target.

The minutes spells out “what the market is implicitly pricing: non-standard measures are difficult to withdraw,” Antoine Bouvet, senior rates strategist at ING, said. “It is reasonable for rates markets to price those measures remaining a feature for a long time.”

German 10-year government bond yields were five basis points lower at -0.69%, not far from the Aug. 16 record low of -0.727% . Its 30-year bond yield, which recorded its biggest one-day rise since September 2017 on Monday, was down four basis at -0.177%.

Reporting by Virginia Furness; editing by Larry King and John Stonestreet

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