Italian bonds rally, safe-haven Bunds sell-off as uncertainty ebbs

German bond yields jumped to their highest level in over a week on Wednesday as the demand for safe-haven assets eased after Italy's 5-Star Movement approved a coalition deal with the Democratic Party and lawmakers opposed to a no-deal Brexit gained the upper hand in Britain. Latest comments from European Central Bank (ECB) policymakers meanwhile dampened expectations for aggressive ECB stimulus next week, fuelling a sell-off in eurozone bonds bar Italy.

Members of the Italian anti-establishment 5-Star Movement overwhelmingly backed a proposed coalition with the center-left Democratic Party (DP) on Tuesday, paving the way for a new government to take office. This means the prospect of a snap election in Italy has receded, easing economic uncertainty.

Brexit uncertainty also eased slightly, after an alliance of opposition lawmakers defeated the government on Tuesday, allowing them to try to pass a law which would force an extension to Britain's exit date. "It looks like the easing of the Brexit concerns to a degree and the recovery in risk sentiment is behind the bond sell-off," said Commerzbank rate strategist Rainer Guntermann.

He said comments from incoming ECB chief Christine Lagarde were in line with recent remarks and provided an excuse for investors to sell bonds. The eurozone economy faces near term challenges so highly accommodative monetary policy for a prolonged period remains necessary, Lagarde said.

Germany's 10-year Bund yield - the euro zone's key safe-haven asset - was set for its biggest one-day jump since June 2018, up 7 bps to -0.64%. Across the eurozone, 10-year bond yields rose 7-8 bps.

Relaunching the ECB'S bond purchasing program is open to debate at the current juncture, Bank of France governor Francois Villeroy de Galhau was quoted as saying in an interview with French newspaper l'Agefi released on Tuesday. The comments helped explain the rise in eurozone bond yields, analysts said.

"This raises the risk that there is disappointment at the upcoming meeting, relative to what markets are expecting," said Benjamin Schroeder, senior rates strategist at ING. ECB policymakers are leaning towards a stimulus package that includes a rate cut, a beefed-up pledge to keep rates low for longer plus compensation for banks over the side-effects of negative rates, though restarting asset purchases remains uncertain, according to a Reuters source-based story on Tuesday.

ITALY SHINES AGAIN

As risk sentiment strengthened, Italy's 10-year bond yield hit a fresh record low of 0.80% and the closely-watched 10-year bond yield gap over safer German Bund yields tightened to around 145 bps -- its narrowest in more than a year.

Italy's bond market has rallied strongly since 5-Star and the PD reached a coalition deal last week. Still, the online ballot results remove a final hurdle to the formation of a new government. "For the time being the vote legitimizes the rally that we have been seeing in the Italian bond market," said Chris Scicluna, head of economic research at Daiwa Capital Markets.

Elsewhere, Greece's 10-year bond yield fell 4 bps to 1.57% after economic growth gained pace in the second quarter.

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