Italian Bonds Sell Off as German Bunds Rally Amid EU Reform Spat

Italy’s 10-year government bonds fell relative to German bunds as a rift emerged over the pace of fiscal reform within the European Union.

Spanish and Portuguese securities also slid as German Finance Minister Wolfgang Schaeuble rejected the possibility of giving states more time to meet their budget targets after a meeting of finance ministers in Brussels. Declines in peripheral bonds were compounded by a slump in European banking shares. German 10-year bonds rose and French yields declined to a record as instability in the Middle East fueled demand for havens.

“In the event sovereigns water down their stability- and growth-pact promises it would weaken the political commitment for fiscal consolidation and structural reforms, weighing on peripheral spreads,” said Norbert Aul, a rates strategist at Nomura International Plc in London.

Italy’s 10-year yield rose three basis points, or 0.03 percentage point, to 2.84 percent at 5 p.m. London time after dropping to a record 2.694 percent last month. The 3.75 percent security maturing September 2024 fell 0.265, or 2.65 euros per 1,000-euro ($1,361) face amount, to 108.135.

The extra yield investors demand to hold the securities instead of similar-maturity German debt widened seven basis points, the steepest increase since June 19, to 162 basis points. The spread has expanded from 132 basis points on June 9, which was the least since April 2011.

Budget Leeway

While finance ministers yesterday signaled governments may be given leeway to fix their economies, Schaeuble said today EU nations shouldn’t use economic overhauls as a reason to avoid meeting budget targets. He and European Commission Vice President Siim Kallas also rebutted a proposal from Italian Prime Minister Matteo Renzi to exclude some investments from budget rules.

The budget tensions threaten a rally that has seen euro-area bonds return 7.3 percent this year through yesterday, according to Bloomberg World Bond Indexes. Yields from Ireland to Portugal have dropped to record lows since the European Central Bank resolved in 2012 to backstop the economic recovery with subdued interest rates and this year added stimulus measures including targeted cheap loans to banks and a negative deposit rate.

Banking Stocks

The STOXX 600 Banks Index of financial institutions in the region fell 2.2 percent, the biggest drop since March, led by declines in Portuguese and Greek lenders.

Spain’s 10-year yield climbed four basis points to 2.72 percent and Portugal’s increased six basis points to 3.65 percent. Rates on similar-maturity Greek bonds jumped nine basis points, the most since June 20, to 6.02 percent.

Italian and Spanish securities also declined before planned debt auctions this week amid concern yields close to those on Treasuries are not justified. U.S. 10-year notes yielded 2.56 percent today.

“From a relative-value perspective, maybe for non-EMU investors there’s not that much value left at the long end of the Italian and Spanish curve, and this could damp demand,” said Christian Lenk, a fixed-income analyst at DZ Bank AG in Frankfurt. “Some investors compare peripheral yields with those of Treasuries and maybe question that we are now trading at or slightly above the Treasury 10-year yield.”

Gaza Fighting

Germany’s bonds, perceived to be among the region’s safest debt securities, rose as Israel struck more than 90 targets in the Hamas-controlled Gaza Strip from air and sea and called up more reservists for a possible ground operation. Fighting in Gaza has escalated three months after the collapse of U.S.- sponsored peace talks and in the shadow of teenagers killed on both sides of the Israeli-Palestinian conflict.

The German benchmark 10-year yield dropped four basis points to 1.22 percent, the lowest since May 3, 2013. The rate on two-year notes was little changed at 0.018 percent. The nation plans to sell 4 billion euros of two-year notes tomorrow.

French 10-year yields also slipped four basis points, to 1.651 percent, a record low.

Volatility on Dutch bonds was the highest in the euro area, followed by those of Belgium and Austria, according to measures of 10-year debt, the yield spread between two- and 10-year securities and credit-default swaps.

German securities earned 4.8 percent this year through yesterday, according to the Bloomberg indexes. Their Italian and Spanish peers gained 9.3 percent and 9.6 percent, respectively.

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