Italy Yields Jump at Auction Before Senate Confidence Vote

Bank of Italy Governor Mario Draghi
Mario Draghi, governor of Italy's central bank, said yesterday the plan is an important step in strengthening the public accounts that will help reduce debt. Photographer: Jock Fistick/Bloomberg

Italy sold five-year bonds at the highest yield in three years and the government was forced to call a confidence vote on an austerity package that aimed to show the nation can tame Europe’s second-largest debt burden.

The Treasury priced 1.25 billion euros ($1.8 billion) of the bonds, the maximum set for the sale, to yield 4.93 percent, the highest since June 2008 and up from 3.9 percent at the previous auction on June 14. It was the first sale of longer-term debt since Italy’s 10-year yield reached a 14-year high of 6.02 percent on July 12. Italy also sold 1.72 billion of 15-years bonds and 2 billion euros of bonds due in 2017 and 2023.

“This is not a result that sweeps away contagion fears, ratings fears,” said Luca Jellinek, head of European interest-rate strategy at Credit Agricole CIB. “Concessions are costly, though not crippling at this point.”

The failure of European Union policy makers to complete a second aid package for Greece and contain the region’s debt crisis fueled concern about the sustainability of Italy’s 1.8 trillion-euro debt, which is larger than that of Greece, Ireland, Spain and Portugal combined. The market selloff that also sent Italy’s benchmark stock index to a two-year low led Prime Minister Silvio Berlusconi to push for speedy passage of 40 billion euros in deficit cuts to balance the budget in 2014.

Demand Rises

Demand for the five-year bonds was 1.93 times the amount on offer, up from the 1.28 times at the June sale. In the secondary market, the yield on similar maturity bonds rose 7 basis points to 5.11 percent. The premium investors demand to hold Italy’s 10-year debt over German bunds rose 15 basis points to 295, down from a euro-era high 348 basis points on July 12.

Bonds extended declines after the government announced that it had requested that today’s vote on the 40 billion-euro deficit-reduction measures would be under a motion of confidence. In Italy governments use confidence votes to maintain party discipline and pressure their own lawmakers to support their position, or risk the collapse of the government. Berlusconi, who has a comfortable majority in the Senate, rarely calls confidence votes in the upper house.

Final Passage

The Chamber of Deputies, where Berlusconi has a narrower margin, holds a confidence vote tomorrow. The Cabinet passed the plan on July 1 to balance the budget in 2014 and initially aimed for parliamentary approval by the end of July. After the market slump, opposition parties pledged not to hinder its passage.

“The likelihood of the Italian budget being passed means short term, we’re expecting the relief rally to continue,” said Harvinder Sian, a senior bond strategist at Royal Bank of Scotland Group Plc in London.

Bank of Italy Governor and incoming European Central Bank President Mario Draghi said yesterday that the plan is “an important step in strengthening the public accounts” that will help reduce debt.

Fitch Ratings called the package “an ambitious fiscal consolidation plan” and said yesterday that sticking to the goals would “be consistent with stabilizing Italy’s sovereign credit profile and rating at AA-.”

Credit Rating

Warnings from Moody’s Investors Service and Standard & Poor’s that they were reviewing Italy’s rating for a possible downgrade, coupled with opposition within Berlusconi’s government to the budget plan designed by Finance Minister Giulio Tremonti, helped drive yields higher this week.

Italy hasn’t had its rating cut since Greece set off the region’s sovereign debt crisis in October 2009. Italy’s deficit of 4.6 percent of gross domestic product last year is less than half those of Greece, Spain and Ireland. Tremonti’s success at containing the shortfall helped limit the increase in the country’s debt, even though total borrowing has topped 100 percent of GDP for more than 20 years.

With its bond yields rising, financing that debt is becoming more expensive. Italy priced 6.75 billion euros of one-year bills to yield 3.67 percent at an auction on July 12, a more than 50 percent increase from the previous sale a month earlier. Limiting the size of today’s auction may have helped bolster demand, said David Schnautz, a fixed-income strategist at Commerzbank AG in London.

Size Matters

“The overall target range of 3 to 5 billion euros is, by Italian standards, fairly low,” Schnautz said before the sale.

Italy will spend about 75 billion euros financing its debt this year, based on the average interest rate of 4 percent forecast by the government. Those projections foresee a jump to 85 billion euros by 2014 as financing costs rise by a point. Jefferies International Ltd. estimates that a rate of 6 percent would cost the government an additional 35 billion euros.

Cutting spending will allow Italy to reduce debt even if 10-year yields top 7 percent for a sustained period, a threshold that prompted Greece, Ireland and Portugal to seek bailouts. That’s because Italy will have a primary surplus -- the budget balance before debt servicing costs -- starting this year. The government projects that surplus will reach 2.4 percent of GDP next year, a figure Draghi said would be the biggest in the EU.

“If you look at Ireland, Portugal and Greece, not one of those issuers failed to get an auction done,” said Padhraic Garvey, the head of developed-market debt at ING Groep NV in Amsterdam. “The problem for those issuers was the cost of funding. That made going to the markets uneconomic.”

Italy still needs to sell about 90 billion euros of bonds this year, about 41 percent of the total for 2011, with a financing hump coming in September when 46 billion euros of debt matures, analysts at BNP Paribas estimate.

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