Rome on Monday officially approved its expansion budget, but markets are relieved that Economy Minister Giovanni Tria remains in office, prompting a strong run in Italian bonds since.
Analysts see a good chance the European Commission will reject Italy's budget, but they said the lack of further shocks in Monday's proposal had prompted further buying of government bonds.
Italy's two-year government bond yield was down seven basis points at 1.52 percent, having been as low as 1.477 percent early in the session, while the 10-year yield slipped four basis points to 3.42 percent .
The 10-year Italy/Germany bond yield spread held below 300 basis points, a level analysts deem to be a threshold for buying or selling Italian debt. It was last at 295 bps, having recorded its biggest one-day fall in nearly two weeks on Tuesday.
Last week, many appeared to be positioning for worse news on the budget front, with data suggesting investors were going heavily short on Italian debt, said UniCredit rates strategist Luca Cazzulani.
Thomson Reuters data shows that open interest in short-dated BTP futures was at its highest in over a year on Oct. 11, and remained elevated for the rest of the week.
"The fact that you had such high open interest at a time of dropping bond prices suggests that a lot of shorts were coming into the market," said Cazzulani. "With the absence of any negative news this week, some of that will come out."
He said that a general improvement in risk sentiment in global markets has helped lift Italian bonds as well.
"Just look at what US equities are doing in the last couple of days, the effect of this (on Italian bonds) should not be downplayed," he said.
The S&P 500 index was up over 2 percent overnight. European stock markets were also up 2 percent on Wednesday on the back of strong earnings .
Italian Prime Minister Giuseppe Conte said on Tuesday he was proud of the budget, adding that austerity was no longer a path Italy could follow.
The relief rally could be short-lived as Italy's credit rating and the European Commission's response to Italy's budget proposal come into focus.
"If we accepted everything that the Italian government was proposing, we would see a virulent counter-reaction from other euro zone countries," commission president Jean-Claude Juncker told reporters in Brussels.
The commission has two weeks to review Italy's fiscal plans. It could reject them completely and ask Rome to rewrite them, an unprecedented step that would formally begin a long dispute .
Elsewhere, euro zone bond yields were benefiting from improved global risk appetite, with Portuguese and Spanish government bonds extending Tuesday's falls.
Germany's government bond yield, the benchmark for the region, also opened lower, below 0.5 percent, and was last around 0.478 percent.