* Merkel won't seek re-election as party head- source
* German bond yields rise, underperform EZ peers
* Italian yields fall to almost one-month lows
* S&P leaves Italy's ratings unchanged, lowers outlook (Updates prices)By Dhara RanasingheLONDON, Oct 29 (Reuters) - German bond yields rose on Mondayafter Chancellor Angela Merkel said she would not seekre-election as party chairwoman and that her fourth term aschancellor would be her last, while Italian yields fell onrelief at an unchanged ratings verdict from S&P.Merkel has been chairwoman of her conservative ChristianDemocrats (CDU) since 2000 and chancellor since 2005. Herdecision to step down as chairwoman comes after her partysuffered its second regional election setback in as many weeks.The move also sets in motion the process for the CDU tosettle on, and groom, Merkel's successor. While German bonds, regarded as one of the safest assets inthe world, often benefit from uncertainty, the implications oflatest political developments left even German bond investorsslightly rattled while the euro weakened. "This news would signal the quality of German credit woulddeteriorate because markets are extrapolating from the resultsof the weekend state election to conclude that the nextgovernment will have a bigger populist portion to it," saidMizuho rates strategist Peter Chatwell."So that explains the rise in German yields but there isalso a need to treat German bonds as a risk-free (investment),so if there was a lot of stress a selloff would be limited."Germany's benchmark 10-year Bund yield rose three basispoints to 0.38 percent , above seven-week lows hitlast week at around 0.34 percent.Across the German curve, yields were up 2-5 bps on the day.The risk of the German coalition collapsing before the nextelection had risen, analysts said."Perhaps the biggest implications are for the euro zone as awhole," said Jennifer McKeown, chief European economist atCapital Economics. "Given her (Merkel's) weakened position, anagreement over Italy's budget may take longer to reach,increasing the threat of contagion to other markets and addingto the risks to Italian banks."
S&P LIFTFor now, Italian bonds took their steer from news on Fridaythat ratings agency Standard & Poor's had decided to leaveItaly's rating unchanged at BBB, two notches above junk.S&P lowered the ratings outlook to negative from stable,saying that the new government's policy plans were weighing onthe country's growth and debt prospects. But the decision to leave the rating unchanged, a week afterMoody's downgraded its Italy rating, bought some relief.Italy's 10-year bond yield fell to its lowest in almost amonth at 3.29 percent , before settling at around3.32 percent by the close.
The gap over top-rated German bond yields narrowed to 294bps from around 306 bps late Friday ."The underlying budget concern is an ongoing issue but theratings risks are out of the way for the rest of the year asthere are no more scheduled ratings decisions," said Commerzbankrates strategist Rainer Guntermann.
Lower Italian yields dragged Spanish and Portuguese yieldsdown, but the selloff in German bondsand a firmer tone in European stock markets pushed up yields onhigher-rated euro zone bonds. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^Italian credit ratings Bund yields set for biggest 1-day jump in almost a month ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Reporting by Dhara Ranasinghe, editing by Richard Balmforth,William Maclean)
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