October 30, 2018 / 11:37 AM / 16 days ago

UPDATE 2-Flatlining economy bruises Italy's government bonds

* Italy’s bond market lags peers after GDP data

* Italian economy grinds to halt in third quarter

* Italian yields up to 14 bps higher on day (Updates with German inflation number, comment)

By Abhinav Ramnarayan and Dhara Ranasinghe

LONDON, Oct 30 (Reuters) - Italian government bonds were hit on Tuesday by data showing the country’s economy flatlined in the third quarter of the year, while a 5.5 billion euro auction pushed yields even higher.

Italy’s economy ground to a halt in the third quarter, data showed on Tuesday, as both domestic demand and trade flows failed to spur any growth, while euro zone growth disappointed for the same period.

Yields on Italian government bonds were eight to 14 basis points higher on the day.

“It’s a surprisingly weak Italian GDP number, it kind of puts an end to the expectations that the government has that they can base their budget on their current growth projections,” said ING rates strategist Benjamin Schroeder.

“It highlights how out of touch some of the assumptions of the Italian government were on this backdrop.”

Italy’s government assumes economic growth of 1.5 percent in 2019, higher than the 1.1 percent growth projected by the European Commission.

Those economic projections are the base for Rome’s plans to increase the budget deficit next year. Last week, the European Commission rejected Italy’s draft 2019 budget because it broke EU rules.

Italy’s 10-year bond yield was last up 14 bps at 3.47 percent, above Monday’s almost one-month low of 3.27 percent hit on relief that Standard & Poor’s did not downgrade Italy’s credit rating after a review on Friday.

The spread over yields on German debt was at 309 bps , having narrowed on Monday to around 287 bps.

Fresh supply added to the upward pressure on Italian yields.

Italy’s Treasury raised the top planned amount of 5.5 billion euros ($6.2 billion) over three bonds.

While weak Italian economic growth data hurt Italian bonds, softer-than-expected euro zone GDP data and the selloff in Italian debt leant some support to higher rated bond markets.

In Germany, the euro zone’s benchmark bond issuer, 10-year bonds yields were down about a basis point at 0.37 percent.

Data showed the euro zone economy grew 1.7 percent in the third quarter compared with 2.2 percent expansion in the previous quarter, adding to a view that an unwind from the European Central Bank’s ultra-easy monetary policy will be slow.

“Softer growth will likely trigger a debate at the ECB whether the guarantee to keep interest rates at their current record-low levels should be extended beyond the summer of 2019,” said Berenberg economist Florian Hense said in a note.

For now, the GDP data also offset strong German inflation data. German annual inflation picked up in October to 2.4 percent — reaching its highest level in more than 6-1/2 years. (Editing by Alison Williams, William Maclean)

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