Italian yields hit euro-era highs in €7.5bn auction

ITALY WAS forced to pay yields at euro-era highs at an auction of €7.5 billion of debt yesterday but managed to raise an amount close to the upper end of its target range, which calmed market nerves ahead of further euro zone sales this week.

France insisted its public finances were in good shape after reports said the outlook on its credit rating could be changed to negative within days.

Slow growth, a heavy deficit and its banks’ exposure to weak southern European economies have raised doubts about France’s ability to hold on to its top-notch AAA rating. Two ratings agencies – Moody’s and Fitch – have recently warned that pressure on its outlook is building.

The yield for Italy’s 10-year bonds was 7.56 per cent, up from 6.06 per cent at the most recent auction a month ago. The yield on a new three-year bond soared to 7.89 per cent.

Traders said the auction was a success in as much as the money was raised, but the extremely high yields were a worrying sign.

One said: “Italian yields are just not sustainable at these levels. They will need to get yields down and it is difficult to see how as so many investors have lost confidence in the Italian market.”

The spread between Italian and German 10-year bonds fell after the auction from 513 basis points (bp) to about 490bp but then rose back above 500bp. France and Spain are due to issue up to €8 billion worth of bonds tomorrow.

Some analysts said such high yields, though unsustainable in the long term, could be paid by Italy to build up funds to meet bond redemptions of some €200 billion that fall due in the first months of 2012. Others say the risk is that there will be a lurch higher in Italian borrowing costs as confidence caves further because people increasingly want to cut exposure.

French concerns grew yesterday when financial daily La Tribunereported that Standard & Poor's, which has warned that a new euro zone recession may hit the country's rating, could switch its outlook on France to negative within days. The agency did not comment on the report, which the paper said came from diplomatic sources.

A downgrade would cost France up to €3 billion a year in extra interest payments.

European anxiety was compounded when Moody’s announced it could downgrade the subordinated debt of 87 banks across 15 EU states, citing concerns that governments could struggle to bail out holders of riskier debt.

Moody’s said the greatest number of ratings to be reviewed were in Spain, Italy, Austria and France, with bonds from banks such as BNP Paribas, Société Générale, Santander and Dexia included in the review. – (Additional reporting: Copyright Financial Times Limited 2011)