Italy's debt costs fall after auction

Italy saw investors more willing to part with their cash today as it raised 10.7 billion euro in a pair of auctions, a sign that market jitters may be easing as the country presses ahead with its austerity measures.

The lower rates Italy had to pay are the first post-Christmas test of sentiment in the markets over the debt crisis that has engulfed the 17 countries that use the euro, and may be a signal that some of last week's massive injection of money into the European banking system from the European Central Bank may be filtering through into government bonds.

The scale of the falls in Italy's funding costs were dramatic and helped the country's benchmark ten-year bond yield in the markets ease further below the seven per cent level, widely considered to be unsustainable in the long-run.

The Bank of Italy said the average yield on its nine billion euro six-month bill offering was 3.251 per cent, half the 6.504 percent rate it had to pay at the equivalent auction last month. And an auction of two-year bonds, which raised 1.732 billion euro, also saw the yield fall to 4.853 per cent from 7.814 per cent last month.

“This is an encouraging development, suggesting that the Italian sovereign debt market has pulled back from the dangerous situation in late November,” said Raj Badiani, a senior economist at IHS Global Insight.

“The calmer environment reflects the passing of additional austerity measures and some welcome progress on the structural reform agenda, coupled with the ECB's decision to provide additional cheap financing to Italian banks,” Badiani added.

Italy is the eurozone's third-largest economy and is considered too big to save under the eurozone's current bailout funds. Markets have grown fearful over the past few months that Italy will find it difficult to pay off its massive debts, which stand at around 1.9 trillion euro. A further test of investors' appetite for Italian debt will come Thursday when the country offers more bonds, that could potentially raise a similar amount to today's offerings.

Mario Monti, the country's new premier, got parliamentary approval last week for more spending cuts and tax increases intended to save the country from financial disaster. One of the most controversial aspects of the austerity package is reform of Italy's bloated pension system.

Later today, Monti is to chair a Cabinet meeting on a second wave of measures designed to boost Italy's flagging economy, which is expected to enter into recession in the first quarter of the new year.

As well as a possible consequence of increased confidence that Monti's efforts will keep the country's finances on a sustainable path, today's auctions could also have been supported as well by a large infusion of credit to eurozone banks last week from the European Central Bank.

There has been speculation that the stronger banks might use the cheap, long-term loans — on which the current interest rate is 1 per cent — to purchase government bonds that carry higher interest rates and profit from the difference.

That could support both government and bank finances. But it would run contrary to efforts by many banks to lower their exposure to bonds issued by heavily indebted governments.

The markets responded fairly positively to today's auctions, with the main FTSE MIB index of leading Italian shares up 0.6 per cent — and the yield on the country's 10-year bond back down at 6.75 per cent.

AP