By Emelia Sithole-Matarise and Marius Zaharia
LONDON, Oct 2 (Reuters) - Italian government bond yieldsfell on Wednesday after Prime Minister Enrico Letta won aconfidence vote from lawmakers following former premier SilvioBerlusconi's climbdown from threats to topple the coalition.
Italian debt outperformed other euro zone bonds, which were steady to slightly weaker after the European Central Bank leftkey interest rates unchanged and gave no hint fresh monetaryeasing was imminent.
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.
Berlusconi backed off just before the confidence vote inparliament after divisions within his camp widened sharply thisweek, easing market concern that Italy could face a fresh roundof potentially inconclusive elections.
"We can continue to see the relief rally going on in ItalianBTPs after Berlusconi's PDL guys backed Letta, weakeningBerlusconi quite considerably," said David Schnautz, a seniorstrategist at Commerzbank in New York.
"On a short term basis the domestic newsflow out of Italy isas close to as good as it can get. The situation was close tothe brink but it's not like now we have a firm or stablegovernment. Overall, there's structural instability which isstill prevailing."
Italian 10-year yields fell more than 10 basis points to4.34 percent, reversing a recent rise which tookthem over 4.70 percent. They were back to levels seen a week agojust before the media tycoon and former prime minsiter's alliesthreatened to bring the government down if he was evicted fromparliament following a tax fraud conviction.
The cost to insure Italian debt against default viafive-year credit default swaps fell 6 basis point to 248 basispoints, 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.
Italian bonds also clawed back some ground against Spanishequivalents, though 10-year yields were still 11 bps aboveSpanish ones.
"Short-term there's potential we may see more switching outof Spain into Italy but overall we see the 10-year Italian yieldfalling to 4.25 percent," Schnautz said.
ECB STANDS PAT
The first U.S. government shutdown in 17 years was havinglittle impact on the region's debt markets as many investorsview it as only temporary.
German Bund futures rose 6 ticks to settle at140.32 after ECB President Mario Draghi signalled no imminentpolicy easing. He reiterated the bank was watching moves inmarket interest rates closely and was ready to use any policyoption to temper them if needed.
"We continue to envisage another very long-term refinancingoperation before year end, likely with differentcharacteristics, for example fixed to the current benchmarkinterest tate, if the liquidity surplus continues to shrink inthe coming months," Barclays Capital strategists said in a note.
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.
- Enrico Letta
- Silvio Berlusconi