By Marius Zaharia
LONDON, Oct 2 (Reuters) - Italian bonds firmed on Wednesday on expectations Prime Minister Enrico Letta will survive a confidence vote with the support of dissidents from Silvio Berlusconi's centre-right party.
Italian debt outperformed other euro zone bonds, which were broadly steady before a European Central Bank meeting later in the day. The first U.S. government shutdown in 17 years was having little impact on the region's debt markets as many investors view it as only temporary.
The confidence vote in Italy was called after five ministers from Berlusconi's party resigned at the weekend. The media tycoon and former prime minister's allies have threatened to bring the government down if he is evicted from parliament following a tax fraud conviction.
But divisions within his camp widened sharply this week, easing market concern that Italy could face a fresh round of potentially inconclusive elections.
The fact that many members of Berlusconi's party were still going to vote against Letta, however, kept up concern about the effectiveness 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 the probability of getting a rational government and constructive policymaking over a period of several quarters remains relatively low."
Italian 10-year bond yields fell 9 basis points to 4.44 percent, reversing a recent rise which took them over 4.70 percent. The cost to insure Italian debt against default via five-year credit default swaps fell 5 basis point to 249 basis points, according to data monitor Markit.
Some analysts say renewed parliament backing might strengthen Letta's authority to push through reforms.
"Maybe Berlusconi pushed it too far this time and ... after all this we could have a more stable government than the one we had before. Italy may come out stronger," Nordea chief analyst Anders Svendsen said.
German Bund futures were 7 ticks up at 140.33, with little movement expected before the ECB meeting.
While the ECB is not expected to make any changes in its monetary policy, investors will be looking for any new hints on whether 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 more LTROs further down the line but they won't do anything at this meeting," ICAP strategist Philip Tyson said.
"Last time they offered LTROs there was a crisis ... this time the market is much more stable."
While Bunds, regarded as a safe-haven asset, showed no obvious reaction to the U.S. government shutdown, the cost of insuring U.S. government bonds for one year rose above that of insuring the debt for five years for the first time since July 2011.
The curve inversion is considered a classic sign of stress as normally a longer-term insurance would be costlier.
"That's interesting, but in the event of a U.S. default who is going to pay anything?" Daiwa's Chris Scicluna said of the CDS move. "The event would be catastrophic."