Investors sell Italian bonds as government looks increasingly fragile

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Italian government bonds were underperforming on Tuesday before an address by Prime Minister Giuseppe Conte that could lead to a confidence vote and bring down the Italian government.

Elsewhere, euro zone rates fell back towards record lows as markets remained focused on the prospect of fiscal stimulus in Germany and easing by the European Central Bank.

Investors in Italian bonds have been on tenterhooks since the leader of Italy‘s League Party, Matteo Salvini, called for an end to the coalition government on Aug. 8.

Luigi Di Maio, head of the 5-Star Movement, the League’s coalition partners, signalled the imminent demise of the government on Tuesday with a Facebook post thanking Prime Minister Conte.

Salvini also renewed concerns that spending will further strain Italy‘s finances, and in turn its relationship with the European Union. He said on Tuesday a budget of 50 billion euros ($55 billion) will be needed for 2020 to bring about a “shock” fiscal stimulus.

How the turmoil will end is unclear. Possible outcomes include a new government that would push the League back into opposition.

Ten-year Italian bond yields were up 4.5 basis points to 1.48%. The spread over top-rated Germany was 215 bps .

Elsewhere, Finnish central bank governor Olli Rehn said on Monday that the ECB’s Governing Council was determined to act if the medium-term inflation outlook continues to fall short of its target: close to but below 2%.

Hopes for additional stimulus are also growing after reports that Germany is prepared to increase fiscal spending and after the People’s Bank of China took steps to lower corporate borrowing costs.

China lowered its new lending reference rate on Tuesday, as expected, as the country’s central bank introduced interest-rate reforms to lower corporate borrowing costs.

Analysts also noted that Australia’s central bank discussed unconventional monetary policy at its August board meeting, leaving the door open for further easing. It has already cut rates twice, to 1%.

Minutes of the Reserve Bank of Australia’s Aug. 6 meeting showed it would consider further rate cuts if they were needed to support growth and achieve its 2% to 3% inflation target.

Antoine Bouvet, senior rates strategist at ING, said the central bank’s minutes were the most important news of the day, even though they are not directly related to rates, because of what they say about easing more generally.

“It spells out what the market is implicitly pricing: non-standard measures are difficult to withdraw,” he said. “It is reasonable for rates markets to price those measures remaining a feature for a long time.”

German 10-year government bond yields were five basis points lower at -0.69%, not far from the Aug. 16 record low of -0.727% . Its 30-year bond yield, which recorded its biggest one-day rise since September 2017 on Monday, was down four basis points on the day at -0.177%.

REUTERS