November 26, 2018 / 8:56 AM / 19 days ago

UPDATE 3-Italian bond yields fall as Rome signals cut to deficit target

* Italian officials signal deficit target of 2.0 percent

* Some analysts question market rally

* Italian bond auction last week may have spooked government (Adds Draghi comment, updates prices)

By Virginia Furness

LONDON, Nov 26 (Reuters) - Italian government bond yields briefly fell 20-30 basis points to reach two-month lows on Monday, after reports that Italy’s governing coalition was bowing to pressure from the European Union and may reduce next year’s budget deficit target.

Italy is considering cutting its deficit target to as low as 2.0 percent of gross domestic product to avoid a disciplinary procedure from Brussels, government sources told Reuters.

Rome’s months-long standoff with Brussels over its spending plans has panicked investors nervous about Italian government finances, and the suggestion of a compromise was welcomed by markets on Monday, with investors buying back into Italian debt.

Italy’s 10-year government bond yield fell more than 22 basis points to a two-month low of 3.17 percent, while its spread over higher-rated Germany was at its tightest in over a month at 279 basis points.

The rally eased as the session wore on, and the 10-year yield was set to close at 3.26 percent — still 13 bps lower on the day — while the Italy/Germany 10-year bond yield spread ended the day at 289 bps.

Italian Deputy Prime Minister Matteo Salvini hinted on Sunday at the possibility of tweaking the deficit goal for next year, a move that could open a negotiation between Rome and Brussels to avoid disciplinary measures.

Analysts said pressure to revise the budget came from the lacklustre ‘BTP Italia’ bond sale last week which suggests domestic investors are losing faith in Italian assets.

RISING YIELDS

The Bank of Italy last week warned that rising yields on Italian government bonds were hurting private wealth and undermining the country’s financial sector.

Italy’s government, the euro-zone’s most indebted member, is holding two bond auctions later this week.

“The Italian government should take notice of the several tough messages they received this past week – particularly from the Italian public and Banca d’Italia,” said Erik Nielsen, group chief economist at UniCredit, with reference to poor the BTP Italia take-up.

Other analysts were more cautious about Monday’s rush back into Italian debt, and by 1030 GMT the bonds had erased some of the earlier gains.

Cyril Regnat, a Paris-based fixed income strategist at Natixis, said he was surprised at both the timing of Rome’s apparent shift after Salvini had recently ruled out tweaking the budget, and the market reaction.

“The market is overreacting,” he said. “As of today we don’t have any real backing or figures (to the reports of lowering the budget deficit target).”

He said that a likely fall in Italian economic growth in 2019 would make the probability of hitting a 2.2 percent or 2 percent deficit target “very small”.

Italy’s short-end government bond yields were more than 30 basis points lower at 0.64 percent in early trades before pulling back to trade at 0.83 percent.

Greek 10-year government bond yields were also well bid, and recorded their biggest one-day fall since June as the rally in Italian bonds helped boost support for peripheral assets, and on news of a merger between Greek lender Eurobank and Grivalia Properties.

Elsewhere, German government bond yields came off recent lows, helped by ECB President Mario Draghi’s comments that the euro zone’s loss of growth momentum was mostly normal and not enough to derail plans by the ECB.

Germany’s 10-year government bond yield closed the day two basis points higher at 0.36 percent.

Reporting by Virginia Furness, Additional reporting by Tommy Wilkes, Editing by Dhara Ranasinghe and Ed Osmond

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