UPDATE 2-Italy's bond market survives key auction test

Strong investor demand at an Italian bond sale on Thursday signalled a vote of confidence in the country and kept government bond yields off recent three-month highs.

Italian borrowing costs on five-year and 10-year debt rose to their highest since December 2013 and March 2014 respectively at a bond auction, reflecting heightened concerns that the 2019 budget will see increased spending, adding pressure to the debt laden economy.

But the auction - the first test of appetite for new Italian debt since July - also saw investors willing to put money back into the country, with the Italian Treasury securing funding at the top end of its size target.

Italy sold 7.75 billion euros ($9.06 billion) in four bonds -- two fixed-rate bonds and two floating-rate bonds -- in an auction that comes a day before a closely-watched ratings review by Fitch Ratings.

"(The auction) clearly underscores that valuations have reached levels where investors feel increasingly comfortable to put money back to work," said Christoph Rieger, head of rates strategy at Commerzbank.

STRONG DEMAND

Luca Cazzulani, rates strategist at UniCredit in Milan, noted that the bid-to-cover ratio for the five year bond was 2.12 and the highest in many years.

"(The deal) is important in terms of the country finding a good level of demand for a new bond, which has been issued in fairly large size," he said.

"The amount (of five-year) sold was nearly four billion euros, which in a period of high uncertainty could have weighed on the market. But this is not the case if you look how the auction went."

However, with a chance to pick up some of the highest yielding paper in the euro zone, and 9.5 billion euros of BTP coupons maturing - which investors could put back into the new trade - analysts said the auction did not mean a complete turnaround in attitudes towards Italy.

"While spreads could see some short term relief and stability as a result, this does not imply a turn in sentiment towards Italy," said Mohammed Kazmi, portfolio manager at UBP in an email.

"Instead, investors will now quickly switch their focus onto tomorrow's Fitch rating review and the upcoming budget negotiations which could lead to further BTP volatility."

Analysts do not expect Fitch to downgrade Italy's rating.

Italian bond yields started to climb after the sale having fallen in the immediate aftermath of the auction.

Its 10-year bond yield rose to 3.15 percent, from lows of 3.11 percent earlier in the session. It held below a three-month high hit on Tuesday at 3.21 percent.

Italy's five-year yield rose to 2.41 percent, having fallen to 2.38 percent after the auction.

"Given the intra-day volatility we've seen in Italian bond yields, it's hard to read to much into the market moves right now said Nordea chief analyst Jan von Gerich.

"There is nothing in the auction results that suggest Italy could loose market access."

Elsewhere, data showed inflation in Germany's most populous regions held above the European Central Bank's target rate in August.

Germany's 10-year Bund yield remained pinned near three-week highs at 0.41 percent with the rest of euro zone bond yields around 1 bps lower.

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