Italy/German 10-year bond yield gap stuck above 300 bps before budget deadline

LONDON: Italy's 10-year bond yield gap over Germany hovered above the 300 basis point mark on Tuesday, before a deadline for Rome to re-submit its contentious 2019 budget plan to the European Commission.

Borrowing costs across the euro area edged up as investors braced for new bond supply from Italy, Germany and the Netherlands, although it was Italy that remained in the spotlight.

The European Commission rejected Italy's draft fiscal plan last month and has threatened to impose penalties if it is not revised to conform with EU regulations - something Rome has indicated it is unwilling to do.

If Rome does not present a new budget on Tuesday, the Commission could start disciplinary steps later this month.

Analysts said that with markets positioned for no significant changes to Italy's expansionary budget, any signs of compromise or strong demand at Tuesday's auction would help shore up a battered bond market.

They cited some reports of movement from the Rome on what were seen as over-optimistic growth projections in its expansionary budget.

German conservative Manfred Weber, who is running for the European Union's top job next year, said on Tuesday he wanted to pursue dialogue with Italy to resolve its row with the EU.

"With the political cost of bending to the Commission's demands too steep a political price to pay, we think the vast majority of investors, do not expect the new government's draft to receive a pass from the EC," said Mizuho rates strategist Antoine Bouvet.

"Today might thus prove a bit of an anti-climax for BTP markets and it could be that the widening pressure on the BTP-Bund spread abates if the auction meets sufficient demand."

Italy's 10-year bond yield was up just 1.4 basis points at 3.46 percent, leaving the gap over benchmark German Bund yields at 305 bps -- near Monday's almost two-week highs of 306 bps.

"If confirmed, the unwillingness of the government to change the deficit number for 2019, will remind markets that Italy remains an important source of uncertainty in the euro zone, providing further support for core yields and preventing the 10-year BTP/Bund spread from breaking below the 300 bps threshold," analysts at UniCredit said in a note.

Italy is scheduled to sell 5.5 billion euros of three, seven and 20-year government bonds on Tuesday. The Netherlands is planning to issue up to one billion euros of bonds and Germany is slated to sell two-year debt.

Supply and hopes for a de-escalation of the Sino-U.S. tariff war following reports that China's top trade negotiator was preparing to visit the United States also weighed on higher rated bonds.

Germany's 10-year Bund yield was up 1.3 bps at 0.40 percent , above Monday's almost two-week lows around 0.38 percent.