LONDON: Italian government bonds held their ground on Thursday after markets gave a key debt auction a mixed reception, but with yields under pressure due to concerns it and other peripheral states will struggle to keep their debts in check.
Three-year borrowing costs jumped and demand was below average at the sale of the March 2015 bond. The other paper on offer was better bid, though, and the total amount sold was close to the maximum target of 5 billion euros.
The results matched relatively modest market expectations, doing little to ease concerns that both Italy and Spain will struggle to maintain fiscal discipline and grow their economies at the same time.
"It's not by any means a shocking result, but it doesn't change the big picture very much," DZ Bank rate strategist Michael Leister said.
"We believe the spreads are biased towards further widening although we still prefer Italian debt over Spanish."
Spain is under mounting pressure to implement tough austerity measures while facing a worsening economic outlook.
Having risen by more than half a percentage point since mid-March, 10-year Italian bond yields fell 11 basis points to 5.44 percent on Thursday, narrowing the spread over benchmark German Bunds to 374 points.
Spanish 10-year yields continued to underperform, keeping steady at 5.87 percent.
Peripheral bond prices were also underpinned by talk the European Central Bank might re-activate its bond-buying programme.
For Spain, the near-term focus is on the psychologically key 6 percent level that, if broken, might raise concerns a door had been opened to 7 percent - a level beyond which debt servicing costs are widely deemed unsustainable.
Peter Allwright, head of absolute return on rates and currency at RWC Partners, which manages assets worth about $4 billion, said markets were slowly heading back towards the stress levels seen in November 2011, before the European Central Bank offered banks massive amounts of cheap three-year cash.
"It's very hard to justify a long (stance on) Spain. We look at housing, ... the regional deficits, the private debt, the banking debt," Allwright said. "While stuck in an uncompetitive currency regime it is very difficult for them.
"There is a lot of hope that the ECB may come in (and buy Spanish bonds)... but we may get to 6.5 percent and 7 percent before they do."
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