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Italian bonds set for worst week of year as election approaches

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02/23/2018 | 06:04pm CEST
Presentation of a new 2 Euro commemorative coin in honour of former German Chancellor Helmut Schmidt

LONDON (Reuters) - Italy's 10-year government bond yield was poised on Friday for its biggest weekly rise of the year, reflecting some unease at the approach of a national election that is expected to result in a hung parliament.

Italian bond markets have so proved resilient in the run-up to the March 4 election thanks to a stronger euro zone economy, a ratings upgrade, the fading risk of a euro-zone break-up and a toning down of anti-euro rhetoric from populist parties.

But with the election just over a week away some uncertainty has crept in, leading to losses for Italian debt and gains for safe-haven German bonds. Markets also digested new bond supply from Italy.

Latest polls point to a hung parliament and analysts expect a short period of volatility that could weigh on bonds and stocks.

Italy's 10-year bond yield was unchanged and lagging better rated peers at 2.07 percent <IT10YT=TWEB>. It has risen about 8 bps this week, set for its biggest weekly rise since December, according to Tradeweb data.

That has left the gap between Italian bond yields and those of benchmark euro zone issuer Germany at around 141 bps, its widest since January.

Still, this gap - a gauge of how investors view relative country risks - remains close to the some 126 bps it stood at in early February, which was the tightest in over a year.

"If I just observe bond yield spreads for now, they have compressed, which suggests there is confidence relative to the outcome of the Italian election," said J Patrick Bradley, senior vice president, investment research at Brandywine Global.

"That is surprising given the uncertainty."

The cost of insuring exposure to Italian sovereign debt hit the highest in more than five weeks. Italy's 5-year credit default swaps <ITGV5YUSAC=MG> rose by 1 basis point from Thursday's close to 105 bps, according to data from IHS Markit.

Most euro zone bond yields fell on Friday, with Germany's 10-year Bund yield down 5 bps to a near one-month low at 0.65 percent <DE10YT=RR>.

Analysts noted comments from European Commission President Jean-Claude Juncker this week, who was reported warning about Italian election risk.

"Some long-forgotten patterns return to euro bond markets with Bunds rallying while Italy sells off," said Commerzbank rates strategist Christoph Rieger.

"Juncker's election warning seems more like an excuse rather than an explanation, but it underscores that markets should become increasingly jittery in coming days when the election grabs more headlines."

To view a graphic on Italian bond set for worst week of the year so far, click: http://reut.rs/2ENBX4Q

(Reporting by Dhara Ranasinghe; Additional reporting by Karin Strohecker; Editing by Richard Balmforth and John Stonestreet)

By Dhara Ranasinghe

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