June 25, 2018 / 7:38 AM / 5 months ago

UPDATE 3-Migration discord, trade tensions hit euro zone bond markets

* Migration issue could hit euro zone integration plans

* Political ructions in Germany boost demand for Bunds

* Italy debt sells off as League gains in municipal vote

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices to close)

By Abhinav Ramnarayan

LONDON, June 25 (Reuters) - Italian bonds sold off on Monday and safe-haven German Bunds were in demand as a debate over migration threatened to widen divisions within the euro zone and undermine German Chancellor Angela Merkel’s authority.

While the migration issue itself is not a primary concern for markets, the effect it could have on euro zone integration and the potentially damaging rift it has provoked within the government in Berlin are worrying investors, analysts said.

The debate also coincides with heightened trade tensions with the United States and falling oil prices.

Merkel conceded on Sunday that the bloc had failed to find a joint solution to the migration issue, and said she would seek direct deals with individual EU states.

Meanwhile, Italy’s ruling right-wing League party gained ground in local elections, strengthening its hand as it cracks down on immigrants fleeing Africa and urges the EU to revise its policy on asylum-seekers.

“It looks like all the news flow over the weekend hasn’t been too encouraging for risk sentiment,” said Commerzbank rates strategist Michael Leister. “The ongoing standoff in Germany and the risk to the coalition government is providing a decent bid for Bunds.”

He said that though the topic of migration was not a major concern for markets, the impact it could have in Germany and on French President Emmanuel Macron’s plans for further euro zone integration were a worry.

With migration likely to dominate an EU summit on Thursday, Italy was in the spotlight, particularly the anti-EU stance of League leader Matteo Salvini.

“It seems like Salvini is dictating the agenda and ultimately if the (Italian) coalition breaks down, the polls are in his favour and he could end up heading the next government,” said Mizuho strategist Antoine Bouvet.

Italy’s 10-year government bond yield jumped 11 basis points to 2.83 percent and its spread over Germany - an indicator of sentiment towards the bloc as a whole - hit its widest level in two weeks at 250 bps.

Italian two-year yields, an indicator of market worries over redenomination risk, rose 10 bps to breach 1 percent, and the two-to-ten-year curve was at its flattest in two weeks.

German bonds tend to perform well at times of trouble, and the benchmark 10-year bond yield hit its lowest in nearly a month at 0.30 percent, before settling at 0.32 percent in late trade.

Meanwhile, German business confidence deteriorated in June, a survey showed on Monday, suggesting the mood among company executives in Europe’s biggest economy is darkening as the world edges towards a full-blown trade war.

Mizuho’s Bouvet said broader worries over trade tensions helped keep safe-haven bond yields lower.

U.S. Treasury Secretary Steven Mnuchin said on Monday that forthcoming investment restrictions from the Treasury will not be specific to China but would apply “to all countries that are trying to steal our technology.”

Reporting by Abhinav Ramnarayan Editing by Peter Graff

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