Italian two-year yield hits six-month low as Rome cuts deficit goal

LONDON: Short-dated Italian bond yields hit their lowest level in six months on Thursday after Rome confirmed it would cut its deficit goal for 2019, potentially ending months of wrangling with Brussels.

The news came just before a European Central Bank meeting where policymakers are expected to announce the end of the 2.6 trillion-euro bond-buying scheme put in place in 2015.

Italian Prime Minister Giuseppe Conte said the government had cut its deficit target for next year to 2.04 percent of gross domestic product from the 2.4 percent it had originally proposed, and expected the European Commission to accept the proposal.

"I think the momentum can carry on in the near term as we have a number of supportive factors for Italian debt, beyond just the hopes the budget deal can be reached," said Commerzbank rates strategist Christoph Rieger.

He said increased speculation of new elections in 2019 -- with Matteo Salvini's League party leading the polls -- could be one of the positives for Italian debt.

Short-dated Italian yields were down 12 basis points to 0.47 percent, a six-month low, and below the levels reached before the May 29 selloff, which was the worst day for two-year Italian debt in 25 years.

Italy's five-year and 10-year government bond yields dropped to their lowest level in 2-1/2 months, trading at 1.91 percent and 2.89 percent respectively, down 12 to 16 basis points on the day.

The closely watched Italy/Germany 10-year bond yield spread was at its tightest since late September, at 261 basis points.

However, Allianz chief economic adviser Mohamed El-Erian warned that tensions could resurface.

"The main issue remains Italy's ability to generate higher growth. Without that, it's just a matter of time until this and other tensions resurface," he tweeted.

Italian assets are also benefiting from an improved mood on world markets, which are rallying on hopes of a thaw in the Sino-US trade war. European shares were up on the day, with Italy outperforming. Its banking shares were up 3 percent .

Most higher-rated euro zone bond yields were marginally higher on the day, ahead of the ECB meeting. German 10-year yields were up a basis point to 0.28 percent, having briefly hit a one-week high of 0.298 percent in early trade.

"I think there are some dovish hopes built into market prices, but I think they will look to maintain the highest flexibility possible," said Commerzbank's Rieger.