AMSTERDAM, Jan 22 (Reuters) - Italian bond yields rose further on Friday as focus turned back to political uncertainty in Rome, a day after yields jumped when a European Central Bank message was perceived as more hawkish than expected.
The Italian newspaper Corriere della Sera reported that Prime Minister Giuseppe Conte was increasingly tempted by a snap election. That prompted the sell-off in Italy’s government bonds on Friday, according to Rabobank analysts.
Conte is under pressure as he faces a vote next week on the country’s justice system and could face more pressure to resign if he loses.
Conte, who won a confidence vote last week after his coalition broke up, cannot call elections himself and the president could appoint a different government if he resigns.
The news comes after the European Central Bank’s policy decision on Thursday. Market participants saw the bank as emphasizing it would not need to use all the firepower of its pandemic emergency bond purchases (PEPP) if favourable financing conditions can be maintained without exhausting the envelope.
Government bonds from Italy and Spain -- who rely on ECB purchases to keep a lid on their borrowing costs as they take on record levels of debt to fight the pandemic -- sold off heavily, pushing yields to their highest since early November.
With political uncertainty back on the cards, Italian bond yields rose further on Friday, with the 10-year benchmark yield rising as much as 6 basis points to 0.72%.
The gap between Italy and Germany’s 10-year yields -- effectively the risk premium on Italian debt -- rose to its highest since mid-November at 120 basis points, above levels touched during last week’s government turmoil in Rome.
“The market was pricing the election chances at zero at the turn of the year, then when we had deterioration in the political situation, I guess they probably raised that probability to something around 5 or 10%,” said James Athey, investment director at Aberdeen Standard Investment.
“To see a headline from the prime minister himself on reports that he is considering an election is kind of a shock to the market, so we’re seeing Italian yields rising, spreads widening.”
Uncertainty around politics, coupled with the market reaction to the ECB, set Italian 10-year yields on track for their biggest weekly rise since mid-April, up 12 basis points this week.
“It is a sensible reaction to reduce positions if you believe the ECB is less dovish and then test where the ECB steps in,” said Sebastien Galy, senior macro strategist at Nordea Asset Management.
Bonds got marginal support from business activity readings, which showed economic activity in the euro zone shrank slightly more than expected in January as lockdown restrictions hit the bloc’s dominant service industry.
Germany’s 10-year yield, the benchmark for the euro area, was last down 1 basis point to -0.51%, off eight-day highs touched on Thursday.
(Reporting by Yoruk Bahceli, additional reporting by Tom Arnold in London, Stefano Rebaudo and Stefano Bernabei in Milan; editing by Larry King)