Italian 10-year yields rise above 7 percent

LONDON: Italian 10-year bond yields topped on Wednesday the 7 percent level widely deemed unsustainable after an increase in the cost of using the country's bonds to raise funds offset hopes for more reforms in Italy as its prime minister agreed to step down.

A 7 percent yield was seen by many in markets as a red line as countries such as Portugal and Ireland were forced to seek financial aid after yields on their bonds exceeded that level.

The rise, which followed a move by clearing house LCH.Clearnet SA to increase the margin call on Italian debt , drove the 10-year yield premium over safe-haven German debt above 500 basis points or the first time in the euro era.

"A lot of people are talking about this level. If it's there for the short term it does not make a difference, but it really does feel like it's a bit of an end-game at the moment," one trader said.

Short-term Italian yields rose even more, with the yield on two-year bonds rising above those on 10-year debt also for the first time since the launch of the euro -- a clear signal of investors' rising concern they may not get their money back.

Traders and investors said the European Central Bank, which has been buying Italian bonds in the secondary market since August to keep yields down, stepped in again on Wednesday.

Italy has been the focus of the market anxiety in recent days, with investors increasingly worried that political turmoil is hindering efforts to stop the third biggest euro zone country becoming engulfed by the crisis.

Italy's debt is equivalent to 120 percent of economic output and it is too big to be bailed out with currently available resources.

Berlusconi said on Wednesday he would resign after enacting economic reforms demanded by the European Union.

"Over the last couple of weeks it has become very personal and about Berlusconi," said Gary Jenkins, fixed income strategist at Evolution Securities.

"But the truth is that the initial sell-off in Italian bonds has all to do with its debt position, the amount of money that needs to be refinanced and the problems in Europe in general."

Italian 10-year yields were 25 bps up at 7.01 percent. Two-year yields were up 79 bps at 7.21 percent. German Bund futures were last 37 ticks up on the day at 138.40.

Berlusconi was seen by many as an obstacle in the way of structural reforms and the sell-off in Italian bonds accelerated earlier this year when he hesitated to pass the austerity steps proposed by his finance minister.

But even when Berlusconi goes, analysts saw no guarantee that reforms to cut debt and boost growth will be quickly implemented.

Questions remained on issues such as whether the European Financial Stability Facility (EFSF) bailout fund will have enough power to fight contagion and whether euro zone policymakers are willing to take further steps against the crisis.

"It is not only Berlusconi's fault that Europe is in a mess," a second trader said.

Commerzbank strategists recommended a tactical short position on Bunds for Wednesday, but stuck to their view that Bund yields will hit new record lows by the end of the year.

The cost of insuring Italian debt against default rose 20 bps on the day to 543 bps.

ECB

Investors will be on alert or any signs that the European Central Bank is willing to step up its Italian bond purchases.

"The problem is that in some ways it is almost impossible for them to withdraw until there is an alternative buyer," Jenkins said.

"If they announce today that they are not going to buy Italian bonds and there is no alternative buyer we will go to double-digits (in Italian yields) in a heartbeat.

The ECB has said its bond purchases are conditional on Italy pursuing reforms.

Copyright Reuters, 2011