Italy sparks sell-off in low-rated euro zone bonds

Italy reignited a sell-off in low-rated euro zone government bonds on Thursday as the spotlight returned to the health of the country’s banks and the political repercussions of a referendum next month.

An index of Italian banking stocks hit its lowest level in five weeks, hit by losses at UniCredit after a newspaper report that it was considering making provisions of €7-8 billion to clean up non-performing loans.

Political uncertainty is also weighing on the sector, with prime minister Matteo Renzi saying on Thursday he would not take part in efforts to form a temporary or technocratic government if he loses next month’s referendum on constitutional reform.

Opinion polls suggest Mr Renzi will lose the December 4th ballot, and he has said he would then resign.

As Italian 10-year government bond yields shot higher, the gap with benchmark German equivalents hit its widest in over two years.

“The markets are afraid of Italy, and that has been behind the spread widening,” said KBC strategist Piet Lammens. “Italian banks are one of the reasons and, of course, the fate of Renzi.”

After initially opening slightly lower on the day, Italian yields shot up 7 basis points to 2.03 per cent, hauling other low-rated euro zone equivalents with it.

Irish yields

Portugal, which has banking concerns of its own, saw yields rise 6 basis points to 3.76 per cent, and Spanish yields rose 4 points to 1.59 per cent.

Irish yields rose 3 basis points at 1.01 per cent, before dropping back below 1 per cent later in the day.

“It’s going to be that much harder to fix Italian banks if he [Renzi] loses, and it looks like it’s going that way,” said ETX capital markets analyst Neil Wilson.

Meanwhile, top-rated German bond yields fell, pulling back from multi-month highs. Analysts said the main driver for lower German yields stemmed from the Bank of Japan’s warning shot to markets not to push borrowing costs too high following Donald Trump’s unexpected victory in last week’s election.

The Bank of Japan (BOJ) on Thursday offered to buy unlimited bonds for the first time under a revamped policy framework, and its governor, Haruhiko Kuroda, said the central bank would not stand idly by as Japanese government bond yields jump in line with moves in US Treasuries.

The Bank of Japan’s decision serves notice to the markets that it is closely monitoring developments as it tries to keep borrowing costs low to spur stubbornly low inflation.

Its efforts also raise questions about how far central banks such as the European Central Bank will be willing to tolerate steep and sudden rises in government bond yields.

“The BOJ’s move shows that there is a bit more of an effort to cap yields and knowing that, other bond markets can be more stable from here,” said Mizuho strategist Peter Chatwell.

Germany

As Japanese government bond yields fell following the BOJ move, Germany’s followed suit. The euro zone benchmark 10-year yield fell as much as 5 basis points to 0.26 per cent, moving away from a 10-month peak of 0.396 per cent hit on Monday.

After an initial dip, US Treasury yields rose when Federal Reserve chair Janet Yellen gave a clear hint the US central bank could hike interest rates next month.

At the auctions, Spain sold €3.9 billion of bonds on Thursday at the high end of the country's target range. However, yields on the three bonds sold jumped against the backdrop of higher borrowing costs. France also sold bonds, maturing in 2021 and 2022 . – Reuters