Italian bonds firm as Letta government seen surviving


By Marius Zaharia

LONDON, Oct 2 (Reuters) - Italian bonds firmed on Wednesdayon expectations Prime Minister Enrico Letta will survive aconfidence vote with the support of dissidents from SilvioBerlusconi's centre-right party.

Italian debt outperformed other euro zone bonds, which werebroadly steady before a European Central Bank meeting later inthe day. The first U.S. government shutdown in 17 years washaving little impact on the region's debt markets as manyinvestors view it as only temporary.

The confidence vote in Italy was called after five ministersfrom Berlusconi's party resigned at the weekend. The mediatycoon and former prime minister's allies have threatened tobring the government down if he is evicted from parliamentfollowing a tax fraud conviction.

But divisions within his camp widened sharply this week,easing market concern that Italy could face a fresh round ofpotentially inconclusive elections.

The fact that many members of Berlusconi's party were stillgoing to vote against Letta, however, kept up concern about theeffectiveness of the left-right coalition in the future.

"We've avoided a near-term crisis," said Chris Scicluna,head of economic research at Daiwa Capital Markets. "But theprobability of getting a rational government and constructivepolicymaking over a period of several quarters remainsrelatively low."

Italian 10-year bond yields fell 9 basispoints to 4.44 percent, reversing a recent rise which took themover 4.70 percent. The cost to insure Italian debt againstdefault via five-year credit default swaps fell 5 basis point to249 basis points, according to data monitor Markit.

Some analysts say renewed parliament backing mightstrengthen Letta's authority to push through reforms.

"Maybe Berlusconi pushed it too far this time and ... afterall this we could have a more stable government than the one wehad before. Italy may come out stronger," Nordea chief analystAnders Svendsen said.


German Bund futures were 7 ticks up at 140.33, withlittle movement expected before the ECB meeting.

While the ECB is not expected to make any changes in itsmonetary policy, investors will be looking for any new hints onwhether it could offer new long-term unlimited loans to banks(LTROs) to keep liquidity ample and short-term rates low.

"They might allude to the fact that there could be moreLTROs further down the line but they won't do anything at thismeeting," ICAP strategist Philip Tyson said.

"Last time they offered LTROs there was a crisis ... thistime the market is much more stable."

While Bunds, regarded as a safe-haven asset, showed noobvious reaction to the U.S. government shutdown, the cost ofinsuring U.S. government bonds for one year rose above that ofinsuring the debt for five years for the first time since July2011.

The curve inversion is considered a classic sign of stressas normally a longer-term insurance would be costlier.

"That's interesting, but in the event of a U.S. default whois going to pay anything?" Daiwa's Chris Scicluna said of theCDS move. "The event would be catastrophic."

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