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* Fiscal concerns pressure Italian bond yields higher
* Bank of England vote, language key for gilts
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Saikat Chatterjee
LONDON, May 10 (Reuters) - Italian government bond yields settled at a seven-week high on Thursday on growing expectations that anti-establishment parties will take power in the euro zone’s third largest economy.
Benchmark 10-year Italian government bond yields jumped 6 basis points to 1.94 percent and the spread between Italian debt and its German counterpart stretched to its widest in six weeks at 138 basis points..
Negotiations on forming a coalition government between the far-right League and the anti-establishment 5-Star Movement are going well and could be wrapped up soon, the two parties said on Thursday.
The 5-Star movement had been signalling for weeks it was ready to form a coalition with the League, but not with its ally, former prime minister Silvio Berlusconi. Late on Wednesday, Berlusconi accepted a demand from 5-Star that his Forza Italia party take no part in the next government.
“With Berlusconi out, an anti-establishment government is one step closer to reality and while both these parties may have their differences, they are united in at least one thing: more fiscal stimulus,” said Antoine Bouvet, a rates strategist at Mizuho in London.
Yields also rose at the short end of the Italian curve, with two-year bond yields rising 3 basis points to a two-month high at minus 0.13 percent.
The spread between two-year and 10-year bonds widened to a six-week high of 206 basis points.
Though a government led by 5-Star might not be the market’s ideal outcome, Morgan Stanley strategists said spreads should move higher only if there was a sharp pick-up in bond issuance to fund any fiscal stimulus plan.
Some investors, such as Charles Diebel, head of rates at Aviva Investors, said once enough yield premium is built in, Italian debt will remain a buy but it does not bode well for the European Union project.
Apart from Italy, robust demand continued for peripheral debt. Data on Thursday showed Japanese investors bought a record 282.1 billion yen ($2.57 billion) of Spanish bonds in March as slim pickings in core European bonds and higher hedging costs for U.S. Treasury debt fuelled demand.
With some European markets closed for holidays, focused shifted to Britain and Thursday’s Bank of England meeting. Market expectations of a rate increase have been pushed back to August, but analysts will be closely watching policymakers for any changes in language or voting patterns.
ING strategists said a combination of a third vote in favour of a rate hike and comments referring to a “transitory” soft patch would lift sterling higher and push UK yields up.
Two-year gilt yields edged 1 basis point up to 0.83 percent.
U.S. inflation data is also likely to help keep any large market moves in check by strengthening expectations the Federal Reserve will raise rates at least three more times this year . (Reporting by Saikat Chatterjee; editing by Larry King)
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