UPDATE 2-Italian bonds rally after change in electoral law rejected

Italian government bonds rallied and outperformed their eurozone peers on Friday after Italy's highest court rejected a proposed change in the electoral law that would probably have benefited the far-right League.

The Constitutional Court on Thursday rejected a request by the League to hold a referendum to introduce a first-past-the-post voting system, replacing a mixed system including proportional voting. Such a system would have increased the chances of a League-led center-right bloc winning a big majority at the next election, putting pressure on the struggling government of the 5-Star Movement and the Democratic Party (PD).

Ten-year Italian government bond yields fell 5 basis points to 1.388% in one of the best sessions for Italian bonds this month. "This is good news from a market perspective because it very much reduces the risk that we would have an absolute majority by the League," said DZ Bank rates strategist Daniel Lenz.

However, uncertainty lingers from another referendum expected to be held on cutting the number of members of Italy's parliament. Most other euro zone bond yields were slightly higher on the day, with Germany's 10-year yield up 1 bps at -0.249%, below the two-week high of -0.16% achieved at the beginning of the month.

In a risk-on session that has seen lower-rated debt and stocks rally, the rally in UK government bonds could arguably be keeping Bund yields from moving higher, said Rabobank's head of rates strategy Richard McGuire. UK government bonds, or gilts, rallied on Friday with the 10-year yield falling to a 2-1/2-month low of 0.612%, last trading 1 bps down on the day after data showed that British consumers failed to increase their spending in December for a record fifth month in a row.

Elsewhere, data on Friday showed China's economy ended a rough year - leading to its weakest growth in nearly 30 years - on a somewhat firmer note. China's trade truce with the United States revived business confidence and earlier growth-boosting measures appeared to be taking hold. Eurozone final inflation numbers came in line with estimates at the start of the month showing inflation picking up to 1.3% from 1% a month earlier.

Moody's will review Portugal's rating later on Friday. The agency changed its outlook on the Baa3 rating to positive in August, meaning that an upgrade is eventually possible. While an upgrade on Friday wouldn't be a huge surprise, "I don't see that so much changed in Portugal in the last six months. It would usually be fair to expect it (an upgrade) to take more time," DZ Bank's Lenz said.

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