LONDON: Italian bonds edged higher on Monday before a debt exchange aimed at easing its 2015 and 2017 repayment burden with prospects of ultra-easy monetary policy countering worries about potential budget slippage.
The European Commission warned Italy on Friday its draft budget for next year risked breaking EU rules. Keeping the budget gap under control is crucial for Italy, which is trying to manage a 2 trillion euro debt pile.
But speculation that the European Central Bank could ease monetary policy further after this month's rate cut maintained investors' appetite for lower-rated debt as they search for higher yields than those offered by safe haven Germany. "Bigger picture, Italy is still OK," one trader said.
Ten-year Italian bond yields fell 2 basis points to 4.08 percent, keeping close to November's five-month lows of 4.04 percent. Taking advantage of the ECB outlook and a record-breaking sale of inflation-linked bonds earlier in November, Italy will offer December 2018 bonds in exchange for some 2015 and 2017 bonds on Monday. It will not offer five-year bonds at its regular end-of-month auction. With its 2013 funding almost completed, Italian bonds will benefit from reduced supply pressure into year-end.
Switching into longer maturities in the debt exchange will give investors a yield pick-up of up to 175 basis points, based on secondary market prices. This is a touch less than they had decided to make such a switch earlier this year, but about 10 bps more than they would get for a similar switch in Spain.
"This is a reasonable level of pick-up and it offers value given that the ECB (outlook) should be supportive for carry trades next year as well," ING rate strategist Alessandro Giansanti said.
He expected 1.5-2.5 billion euros of bonds to be exchanged. This will not make a significant difference to Italy's 2015 and 2017 repayments, but Giansanti expected more debt exchanges early next year.
The diminishing risk of the Italian government collapsing also supported the country's bonds.
Former premier Silvio Berlusconi, facing expulsion from parliament, said on Saturday he may no longer back the coalition but would not be able to bring it down as a group of MPs in his party pledged support for Prime Minister Enrico Letta.
Bund futures were 8 ticks higher at 141.71, while 10-year German yields were flat at 1.71 percent.
Germany's ZEW business sentiment indicator on Tuesday and the minutes from the Federal Reserve's October policy meeting on Wednesday may provide hints to future monetary policy moves.
While investors debate whether the ECB will ease policy further or not, bets on the Fed are about the timing of its planned move to reduce monetary stimulus. Fed chief nominee Janet Yellen signalled last week the central bank was in no rush to scale back asset purchases.
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