LONDON: Italian government bonds fell on Wednesday one day before the country tests market appetite for its bonds with a sale of five-and ten-year paper.
Spanish sovereign debt also eased after economically important Catalonia said it needed a rescue just as data showed the economy falling deeper into recession. The news flow highlighted the urgency of getting the country's funding costs back to sustainable levels.
Italy's two-year borrowing costs fell nearly two percentage points at an auction on Tuesday, benefiting from the prospect of European Central Bank intervention which is expected to focus on the front-end of the curve..
A sale of up to 6.5 billion euros of longer-dated debt on Thursday could prove more challenging.
"It's going to be certainly an interesting litmus test," Richard McGuire, senior fixed income strategist at Rabobank said.
"One would have always expected (Tuesday's) sales to go well given their short-dated nature and the speculation of ECB intervention in the front end of the peripheral curve ensuring a bid for paper there. The 10-year issuance we see in Italy tomorrow will provide a more important barometer in terms of market thinking."
Ten-year Italian yields rose 4.4 basis points to 5.87 percent, while five-year yields were 4.3 bps higher at 4.83 percent.
Benchmark ten-year Spanish government bond yields rose 8.2 basis points to 6.58 percent.
Spanish debt was under pressure across maturities one day after data also showed depositors pulling money out of their banks, leaving domestic institutions -- which have supported the country's sovereign debt market in recent months -- even more fragile.
"All in all the domestic banks look to be in a weaker position in terms of providing funding to the sovereign, which in turn increases pressure on the sovereign to accept a more comprehensive bailout," McGuire added.
TESTING RESISTANCE
German Bund futures reversed early losses to trade 26 ticks higher at 144.22, after breaking above what traders said was a resistance level at 144.17, the 62 percent retracement of the July-August sell-off.
The contract however was expected to remain in tight ranges as investors awaited details on the ECB's plans.
"People are pretty flat ... you can argue there's quite a lot built in around this ECB plan. I think the expectations are fairly big," one trader said.
Investors were also cautious before a speech by Federal Reserve Chairman Ben Bernanke on Friday at Jackson Hole in the US, which will be widely watched for any hints the bank could embark on a third round of quantitative easing.
Any reaction to Bernanke may be limited about one week before the ECB meeting on Sept. 6, analysts said.
"If the ECB delays unveiling the details of its bond-purchasing programme (beyond Sept 6), then risk markets may sell off and Bunds would benefit and may retest September contract highs of 146.26," said Piet Lammens, strategist at KBC.
"But we think that level is a strong resistance and we don't expect it to be broken. Therefore it would be a good opportunity to sell the Bund."
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