Italian-German yield gap narrows on bank clean-up efforts

LONDON: The premium over Germany that Italy pays to borrow in bond markets fell to its lowest in over a month on Tuesday as UniCredit announced Italy's biggest ever share sale in the latest bid to clean up its banking sector.

The country's largest bank said it would raise 13 billion euros ($13.8 billion) to bolster its balance sheet, while new premier Paolo Gentiloni said he would be ready to support the banking sector as another lender Monte dei Paschi struggles to stay afloat.

The fate of Italy's financial sector is intrinsically tied to its government because banks are the biggest investors in the country's bonds.

Gentiloni presented an almost unchanged cabinet on Monday, which analysts said was a welcome response to the political upheaval of a constitutional referendum that unseated his predecessor Matteo Renzi.

"The markets appear to be taking the developments in the banking sector quite positively and the cabinet chosen by Gentiloni has reassured investors," DZ Bank strategist Christian Lenk said. Italy's new government will face confidence votes in both houses of parliament this week.

The small centre-right ALA party that supported Renzi said it might not back the new government, raising doubts over whether Gentiloni will have the numbers in parliament to form a majority.

Italian 10-year government bond yields fell as much as 11 basis points to 1.89 percent on Tuesday, closing in on a one-month low of 1.88 percent. Compared to German equivalents, the premium Italy would pay to borrow 10-year money in debt markets fell to 153 basis points, the lowest in over a month.

German yields fell by a lesser extent - 4 basis points - to 0.36 percent, while most other euro zone yields were 2-8 bps lower on the day.

Italian banking stocks gained 3 percent, hauled up by an 8 percent rise in UniCredit and a 2 percent gain in Monte dei Paschi. "The uncertainty of a major government reshuffling has been removed and investors appear to be cheering developments in the banking sector as well," Commerzbank strategist David Schnautz said.