UPDATE 1-Italian bond auction to test risk appetite

The Italian Treasury is due to sell up to 7.75 billion euros of bonds in an auction on Thursday that will be closely watched as a barometer for risk appetite.

Elsewhere, euro zone bonds yields were largely flat on Wednesday's close.

Italy's anti-establishment government has unnerved investors throughout the summer with continual threats to increase spending, adding pressure to the debt laden economy. As such, bond yields have been volatile and headline driven and the new deal is the first test of appetite for new Italian debt since July.

Italy plans to sell 3-3.75 billion euros of new five-year bonds, along with 1.75- 2.25 billion euros of 10-year bonds and 1.25-1.75 billion euros of floating rate notes maturing October 2024 and September 2025 at auction later this morning.

Italian bond yields fell to their lowest point this week in early trading on Thursday, extending a rally on Wednesday which analysts attributed to a La Stampa article saying that Italy may try to secure help from the European Central Bank.

Its 10-year bond was two basis points tighter at 3.11 percent, a 10 basis point fall from Wednesday's peak of 3.2 percent.

The trade is an important test of investor demand for Italian debt and comes ahead of a scheduled credit rating review of the country by Fitch on Friday.

"BTP supply is in focus and will likely drive sentiment for European risk markets," said Mohammed Kazmi, portfolio manager at UBP in an emailed comment.

BTP spreads had widened in the past month suggesting the auction itself could pass easily, he said.

"That said, this will not change the uncertain outlook that remains on Italy. We see risks as still skewed to the downside for Italy given a potential confrontation with the European Commission over the budget in the coming months and a coalition which is still lacking a clear and consistent voice itself which adds to the uncertainty herein," Kazmi said.

However, analysts also say the market backdrop is not ideal for the auction, with the rally in Italian government bonds over the past two days meaning that Italian bond yields look less attractive to investors.

"We've seen some tightening of the spread, so it's not a great set-up as the bonds look expensive," Rabobank's head of rates strategy Richard McGuire said.

"Yesterday the yield spread over Italy closed 8.5 basis points tighter."

In addition, a report by a local Italian newspaper La Repubblica claims that the upcoming Fitch review will detail high government spending, renewing investor concerns that the upcoming budget may breach the European Union's deficit restrictions.

"If we take this report at face value, the details are not positive," said McGuire.

McGuire said increasing spending by 75 billion euros annually equates to 4.4 percent of nominal GDP which would "blow the 3 percent figure out of the water."

According to the La Repubblica report, Fitch compiled the cost of every measure promised by the coalition government before the election, but the rating agency does not say it expects all measures will be in the upcoming budget plans.

The German states started to announce their August inflation numbers on Thursday, acting as a precursor to broader Eurozone inflation figures due on Friday. Saxony consumer prices were unchanged at 2.0 percent.

10-year Bunds fell marginally to 0.39 percent from the three-week highs at 0.40 percent with the rest of eurozone bond yields flat to marginally lower.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)