LONDON: Italy's 10-year government bond yield rose to a 4 1/2-year high on Monday, after the European Union reiterated its concern over Italy's budget plans while Rome remained defiant.
Italian borrowing costs jumped as much as 22 basis points across the curve, Italy's stock market fell to its lowest since April 2017 and bank shares tumbled.
The European Commission has told Italy it is concerned over its budget deficit plans for the next three years since they breach what the EU asked the country to do in July. Rome insisted on Saturday it would "not retreat" from its spending plans.
Italian Deputy Prime Minister Matteo Salvini said he hoped the Commission would read the budget proposal before rejecting it.
Italy is to submit its draft budget to the Commission, which will check whether it's in line with EU rules, by Oct. 15.
Italy's benchmark 10-year bond yield rose over 10 bps to its highest level since early 2014 at 3.52 percent. Two-year bond yields jumped 22 bps to 1.56 percent -- their highest since a selloff almost a week ago.
"We are a bit surprised by the strength of the reaction in bond markets, but it appears the market is jumping to the conclusion that the European Commission will take a hard-line stance when Italy submits its budget," said Mizuho rates strategist Antoine Bouvet.
In a letter to Italian Economy Minister Giovanni Tria, the Commission said that with a planned headline deficit of 2.4 percent of gross domestic product in 2019, Italy's structural deficit, which excludes one-offs and business cycle effects, would rise by 0.8 percent of GDP.
The EU asked Italy in July to reduce that structural deficit by 0.6 percent of GDP next year, which means the deficit would be 1.4 points off track.
The Italian/German 10-year bond yield gap widened to 294 bps from around 284 bps late on Friday. It held below the key 300 mark briefly topped last week.
"The key point is that the Italian government is issuing comments based on the BTP/Bund spreads, so as we get closer to 300 bps we could get more reassuring comments," said Commerzbank rates strategist Christoph Rieger.
"It's just not clear how long the market will tolerate this game of brinkmanship."
Broader euro zone bond markets were calm after last week's US-led selloff, with 10-year bond yields outside Italy little changed on the day.
Strong data and hawkish comments from US Federal Reserve officials triggered a jump in bond yields last week, although Monday's US public holiday gave investors a chance to pause for thought.
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