June 5, 2019 / 11:27 AM / 13 days ago

UPDATE 2-Italy bonds, bank stocks fall as EU concludes Rome broke debt rules

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By Abhinav Ramnarayan, Danilo Masoni and Virginia Furness

LONDON/MILAN, June 5 (Reuters) - Italian bond yields rose sharply and bank stocks fell on Wednesday after the European Commission concluded that Italy is in breach of EU fiscal rules because of its growing debt, a situation that justifies the launch of a disciplinary procedure.

But the move higher in Italian yields was tempered by a strong rally in core government bond yields as focus returned to monetary policy in both the U.S. and Europe, as well as conciliatory comments from Prime Minister Giuseppe Conte.

The yield on Italy’s 10-year government bond pulled back to 2.516%, down one basis point on the day, having risen sharply to a high of 2.631% earlier in the session.

Yields fell after Conte said the government wanted constructive talks with Brussels to reach a deal over 2019 budget targets, after the European Commission issued a warning over Rome’s finances.

European Economic Commissioner Pierre Moscovici has already insisted that the process could be stopped if new data and commitments from Rome emerged.

But investors remain wary after the European Commission said on Wednesday that Italy’s growing debt broke EU rules, giving it the option of opening a disciplinary procedure that could lead to a prolonged dispute with Rome.

If the European Union countries back this assessment in the next two weeks, the EU executive could subsequently recommend to start the procedure, a move expected before a meeting of EU finance ministers in early July.

Italian bank shares had also taken a hit earlier in the session and were down as much as 2.3% on the day.

“Yes the announced EDP procedure today didn’t come as a shock but is sure to send BTP/Bund spreads wider which matters for banks given their large sovereign bond portfolios,” said Russell Quelch, financials analyst at Redburn, in London.

“On the technicalities, the European Commission has until 1 August to give a final recommendation to the Council, for formal action in Spring so this will likely remain an overhang for some time.”

Pictet Asset Management’s chief strategist Luca Paolini said at a briefing on Tuesday said that he does expect an agreement between Italy and the EU to allow some more spending.

Adding to upward pressure on Italian yields, League’s economics chief said the party will insist Prime Minister Giuseppe Conte takes a tough line in budget talks with the European Commission and will “stop at nothing” to prevent new belt-tightening measures.

Earlier, Germany’s 10-year bond yield reached a record low on Wednesday as investors ramped up their bets on a rate cut in the United States and a generous loan package for banks in the euro zone.

A rally in U.S. Treasuries also gathered steam after data reported the smallest monthly gain in more than nine years in U.S. private sector jobs.

Germany’s 15-year government bond yield also turned negative for the first time.

Most major government bond yields dropped after U.S. Federal Reserve Chair Jerome Powell said overnight the Fed would respond “as appropriate” to the risks posed by a global trade war.

Reporting by Danilo Masoni and Abhinav Ramnarayan, additional reporting by Virginia Furness and Helen Reid; Editing by Helen Reid, William Maclean

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