LONDON: Italian bond yields hit three-week highs on Wednesday, widening the gap over top-rated German peers, after Italy re-submitted its 2019 budget to the European Commission with unchanged growth and budget deficit assumptions but falling debt targets.
Meanwhile yields on higher-rated bonds in the euro zone fell on that news as well as a slide in oil prices and data showing that Germany's economy shrank in the third quarter for the first time since 2015.
But it was the details of Italy's new draft budget that gripped bond investors.
The falling debt forecast in the revised budget, which Italy wants to achieve by using funds from privatisation equal to 1 percent of gross domestic product, is to address one of the Commission's main concerns about the previous draft - that public debt would not fall as required by EU rules.
But the budget still plans to increase the structural deficit, which excludes one-offs and cyclical swings, by 0.8 percent of GDP next year, rather than cut it by 0.6 percent of GDP as required under EU rules.
This, along with what Brussels sees as unrealistically high assumptions on growth, still puts Rome on a collision course with the Commission, which is to give an opinion on the revised draft on Nov. 21.
Italian bond yields rose as much as 9 basis points on the day across maturities at one stage, marking Italy out once again as the weak spot in European fixed-income markets.
"I'm not surprised the market is trading this way and we need to see more signs of a compromise on the budget before we get relief for Italian markets," said Commerzbank rates strategist Rainer Guntermann.
"CRITICAL PHASE"
Yields fell slightly from the day's highs as the session wore on and were about 5-6 bps higher towards the close.
Italy's 10-year bond yield hit a three-week high at around 3.55 percent, before settling at 3.50 percent by the close, pushing the gap over benchmark 10-year German Bund yields to 309 bps from around 303 late on Tuesday.
Italy's five-year credit default swaps jumped 7 basis points from Tuesday's close to a near four-week high of 279 bps, according to data from IHS Markit.
And Italian stocks underperformed their peers, last down 1.25 percent.
Pascal Blanque, the head of Amundi, Europe's biggest fund manager, said Italian bond spreads could go even wider before a solution is found.
"We are in a critical phase between today and the European parliamentary elections (in May 2019). In terms of positioning, we err around neutrality," he told the Reuters Global Investment Outlook Summit.
With the exception of Italy, most 10-year bond yields in the euro area were marginally lower on the day.
Data showing German GDP shrank by 0.2 percent quarter-on-quarter in the third quarter boosted a perception that interest rates in the bloc will remain low for some time.
Tuesday's 7 percent slide in oil prices added to a perception of subdued inflation.
At the same time, the fall in bond yields was limited by new supply from Germany.
In addition, a draft Brexit deal between the UK and European Union reduced demand for safe-haven assets.
Germany's 10-year Bund yield was down one basis point at 0.40 percent.
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