LONDON: Italian bond yields fell towards recent multi-year lows on Monday after Italy's prime minister said at the weekend he was confident that he could finalise talks on a new government by Wednesday.
The 5-Star Movement and the Democratic Party (PD) were in intense discussions over the weekend to hammer out a deal on a common agenda and Cabinet posts.
Italian bond yields fell between four and eight basis points at the opening, having risen on Friday after 5-Star leader Luigi di Maio said his party would only enter a coalition if the PD agreed to a string of policy demands.
5 Star's members will be asked to approve the coalition deal, agreed last week, in an electronic ballot on Tuesday.
Italy's 10-year bond yield fell 5 bps to around 0.99%. But the biggest reaction came from the short end of the curve, which continued to outperform. The two-year yield tumbled 8 bps to -0.24%, close to its lowest levels since April 2018.
"It seems like they'll come up with a coalition agreement treaty so this is good for a slight tightening (in spreads)," said Norbert Wuthe, rates strategist at Bayerische Landesbank.
The Italian/German 10-year bond yield spread stood at 167 bps, nearing levels hit last week around 161 bps, the tightest since May 2018.
Wuthe said the outperformance of short-dated Italian bonds mimicked a similar move in German Bunds, following hawkish statements last week from some European Central Bank officials that had fuelled speculation that the ECB, instead of embarking on fresh asset purchases, could deliver large rate cuts instead.
The ECB meets on Sept. 12 and is widely expected to ease policy to boost economic growth and inflation.
"The decreasing likelihood of quantitative easing came with an increasing likelihood of rate cuts or even stronger rate cuts," Wuthe said.
ECB policy makers Sabine Lautenschlaeger, Luis de Guindos and Benoit Coeure are all due to speak on Monday.
Elsewhere, most euro zone bond yields inched higher, still keeping recent lows in sight.
The United States began imposing 15% tariffs on a variety of Chinese goods on Sunday.
However, China's retaliation imposed additional tariffs on only one-third of the 5,000 products on a $75 billion target list of U.S. goods. This raised hopes of a trade breakthrough before the next round of tariff implementation, Chris Bailey, European strategist at Raymond James, said in a client note.
Germany's federal coalition partners, the Christian Democrats and Social Democrats, held on to Saxony and Brandenburg respectively in weekend regional elections, although the far-right Alternative for Germany made significant gains.
Overall trade was expected to be subdued on Monday by a U.S. public holiday.