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UPDATE 2-Italian bond yields jump as Rome sticks to deficit target

Kitco News

* Italian bond yields at three-week highs

* Italy sticks to growth, deficit plans in revamped budget

* Sets stage for EU showdown

* Core euro zone bond yields down (Adds Italian CDS, updates prices)

By Dhara Ranasinghe

LONDON, Nov 14 (Reuters) - Italian bond yields hit three-week highs on Wednesday, widening the gap over top-rated German peers, after Italy re-submitted its 2019 budget to the European Commission with unchanged growth and budget deficit assumptions but falling debt targets.

Yields on higher-rated bonds in the euro zone fell on renewed volatility in Italy, a slide in oil prices and news that Germany’s economy contracted for the first time since 2015 in the third quarter.

But it was the details of Italy’s new draft budget that gripped bond investors.

The falling debt forecast in the revised budget, which Italy wants to achieve by using funds from privatisation equal to 1 percent of gross domestic product, is to address one of the Commission’s main concerns about the previous draft - that public debt would not fall as required by EU rules.

But the budget still plans to increase the structural deficit, which excludes one-offs and cyclical swings, by 0.8 percent of GDP next year, rather than cut it by 0.6 percent of GDP as required under EU rules.

This, along with what the Commission sees as unrealistically high assumptions on growth, still puts Rome on a collision course with the Commission, which is to give an opinion on the revised draft on Nov. 21.

Consequently, Italian bond yields rose as much as 9 basis points on the day across maturities, marking Italy out once again as the weak spot in European fixed-income markets.

Italy’s 10-year bond yield rose to a three-week high at around 3.55 percent, pushing the gap over benchmark 10-year German Bund yields to 315 bps from around 303 bps late on Tuesday.

Italy’s five-year credit default swaps jumped 7 basis points from Tuesday’s close to a near four-week high of 279 bps, according to data from IHS Markit.

And Italian stocks underperformed their peers, last down 1.25 percent.

“I’m not surprised the market is trading this way and we need to see more signs of a compromise on the budget before we get relief for Italian markets,” said Commerzbank rates strategist Rainer Guntermann.

With the exception of Italy, most 10-year bond yields in the euro area were 1 to 2 bps lower on the day.

Data showing GDP in Germany shrank by 0.2 percent quarter-on-quarter in the third quarter boosted a perception that interest rates in the bloc will remain low for some time.

Tuesday’s 7 percent slide in oil prices added to a perception of subdued inflation in the currency bloc.

At the same time, the fall in bond yields was limited by new supply from Germany.

In addition, a draft Brexit deal between the UK and European Union reduced demand for safe-haven assets.

Germany’s 10-year Bund yield was down 2 bps at 0.39 percent .

Reporting by Dhara Ranasinghe, editing by Larry King

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