UPDATE 2-Italian bond yields tumble as investors hold nerve after EU budget rejection
* EU Commission rejects Italian budget
* Yields down as much as 16 bps on day
* Salvini may be open to review budget -La Stampa
* Salvini not seeking budget deficit changes (Adds Salvini, European Commission comment)
By Virginia Furness
LONDON, Nov 21 (Reuters) - Italian government bond yields fell on Wednesday as some signs of a compromise from Rome on its 2019 budget boosted investor confidence, even as the European Commission rejected the draft and recommended disciplinary procedure.
Bond yields held as much as 16 basis points lower, after receiving a price boost earlier in the session on a newspaper report that Deputy Prime Minister Matteo Salvini may be open to reviewing the 2019 budget.
Salvini said later that he was not open to negotiations over the budget deficit target of 2.4 percent of GDP, though other aspects of the budget could be discussed.
Prime Minister Giuseppe Conte said he is worried about Italy’s bond spread over Germany, and that the government will respond with reforms.
The Italy/Germany 10-year bond yield spread tightened to 316 basis points from lows of 313 bps earlier in the session . It has more than doubled this year.
“There is obviously a hint in the reports from Italy that there might be some tweaks to the budget in due course,” said Chris Scicluna, head of economic research at Daiwa Capital Markets in London.
“I don’t think there will be substantive changes but we did have a significant selloff yesterday, so there’s a better mood around bond markets today.”
The European Commission said that Italy’s budget does not comply with the EU debt reduction criteria and that an excessive deficit procedure is warranted.
While the euro briefly turned negative on the news, and Italy’s benchmark stock index hit a session low, the bond market held up.
Italy’s two-year bond yield was down 17 bps at 1.22 percent while 10-year yields tumbled as much as nine bps to 3.53 percent , and were set for their biggest daily drop in over three weeks.
On Tuesday, the spread widened to as much as 335 basis points with weak demand at a “BTP Italia” retail bond sale weighing on sentiment.
Retail investors took up 723 million euros ($824 million) of the bond on Monday and Tuesday against orders worth 3.7 billion euros over two days for the previous issue.
Analysts remained sceptical about a sustained recovery in Italian bonds.
“We don’t think they’re going to budge (on the budget) much, there might be some word play with the Commission, but Italy is still going to run a deficit of 2.4 percent,” said Lyn Graham Taylor, rates strategist at Rabobank.
Italy has already presented a revised budget to Brussels but made no significant changes.
As Italian bond yields fell, Greece’s bond market also recovered slightly from a heavy selloff in the previous session.
Greek bonds have come under pressure from renewed concern about the strength of the country’s banking sector and contagion from volatility in Italy.
The Commission said on Wednesday that Athens needs to speed up the implementation of its reforms.
The rally in riskier euro zone bonds dented demand for safer debt. Germany’s 10-year bond yield rose 2 basis points to 0.37 percent, while other higher quality government bond yields were also higher,.
Reporting by Virginia Furness; Additional reporting by Dhara Ranasinghe and Sujata Rao; Editing by David Stamp
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