Italian government bond yields sharply higher in trade on Thursday

Reports of government infighting pushed Italian government bond yields sharply higher in early trade on Thursday, though confirmation that a key budget meeting will go ahead prompted a pullback in bond yields from the day's highs.

Italian bond yields rose as much as 22 basis points on Thursday at one stage on worries that a budget meeting would be postponed.

But Italy's government confirmed it will meet on Thursday to approve its new public finance and growth targets, the prime minister's office said in a note.

The renewed risk boosted safe-haven German bond prices, with 10-year yields dropping five bps and Italian yield premia over their German counterparts widening.

The outsize market moves were attributed by analysts to a report by Corriere della Serra that the budget meeting scheduled for 1600 GMT was likely to be delayed.

The new twist in the Italian budget saga stands in contrast to recent signs that Economy Minister Giovanni Tria and coalition partners Matteo Salvini and Luigi di Maio had reached an agreement. Tria has pledged to keep the deficit under control, has defied calls for higher spending.

Those hopes had prompted a rally in Italian bonds, but the rally faded after a report late on Wednesday that the far-right League had sided with coalition partner 5-Star to push for a higher deficit of 2.4 percent of GDP, renewing concerns of higher government spending.

Italian bond yields fell from the day's highs, though they were still 7-14 bps up on the day by mid-morning. Its two-year yields were at 0.88, having jumped 23 bps to a high of 0.96 percent. Five-year yields edged back down to 1.97 having touched 2.04 percent, up around 19 bps and 10-year yields were at 2.95 percent having risen 14 bps. Two-year yields have so far posted their biggest one-day rise since the end of June.

"Il Corriere suggests the budget meeting may be postponed because there are new complications in reaching an agreement on the deficit," said ING rates strategist Martin van Vliet. "It is driving the market this morning, and the euro was also down."

The euro slipped 0.3 percent on the day to $ 1.1703. Shares in Italy's banks, big holders of government bonds, fell 1.9 percent at the open. Italian five-year credit default swaps surged eight basis points to a 10-day high, according to IHS Markit.

Markets were also spooked earlier by a La Stampa report that Economy Minister Tria planned to resign. The ministry denied the report.

"(The sell-off) is in contrast to the recent move into Italy," DZ Bank analyst Rene Albrecht said. "We saw investors buying Italian debt because of the carry, and now they are worried that the Italian finance minister could resign and the budget could be blown. Uncertainty is higher than before."

The sell-off pushed the premium investors to demand to hold Italian bonds over the German benchmark out by 10 bps to a 10-day high of 247 bps.

However, Italy did generate solid demand for an auction of Oct 2023 and Dec 2028 bonds, raising the maximum targeted amount of 5.25 billion euros from the sale.

Germany's 10-year bond yield fell five basis points to below 0.49 percent, also tracking the move lower in U.S. Treasuries following a rate hike on Wednesday.

"The Bund is just catching up to the move in Treasuries on the back of the Fed statement," said ING's van Vliet. "The Fed signaled more hikes, but they removed the accommodative reference. The market is now focussed on the dovish element."

The U.S. Federal Reserve raised its benchmark overnight lending rate on Wednesday by a quarter of a percentage point, to a range of 2.00 percent to 2.25 percent.