Borrowing Costs Ease, But Italian Debt Still A Hard Sell

Italian borrowing costs continued to ease on Thursday, but interest rates on the longest-term debt remained near unsustainable levels following an undersubscribed auction.

The Italian Treasury sold just above EUR 7 billion of long term debt at an auction on Thursday, which was less than its maximum target of EUR 8.5 billion.

While 3-year yields eased significantly, the yield on the 10-year debt was down only nominally, suggesting that investors remain concerned over the country's creditworthiness.

The agency placed EUR 2.5 billion of March 2022 5 percent bonds at an average yield of 6.98 percent, down from 7.56 percent in the previous auction on November 29. Demand was 1.36 times the amount on offer, slightly higher than 1.34 in the previous auction. The maximum target set for the sale was EUR 2.5 billion.

The yield on the 10-year debt remains near 7 percent, a level seen unsustainable, raising concerns that the country may fail to raise funds. Eurozone members Portugal and Ireland were prompted to seek bailouts after their bond yields crossed the crucial 7 percent mark.

Italy also sold EUR 2.5 billion of three-year debt, which was less than the maximum target of EUR 3 billion. The yield on the 6 percent bonds maturing in November 2014 fell to 5.62 percent from 7.89 percent in the November sale. But, the bid-to-cover ratio dropped to 1.36 from 1.50.

Further, the Treasury sold EUR 1.176 billion of 4.75 percent bonds maturing in September 2021 at a yield of 6.70 percent. Demand was 1.58 times the amount on offer. The agency also raised EUR 803 million from the sale of a floating-rate bond maturing in April 2018.

Today's auction results were less upbeat than those from a sale yesterday, which saw Italian borrowing costs for 6-month debt plummet. The Treasury successfully sold EUR 9 billion of 179-day bills at a rate of 3.251 percent, half of the euro-record 6.504 percent paid in the previous auction held on November 25. Demand also improved with the bid-to-cover ratio rising to 1.69 from 1.47.

Meanwhile, Prime Minister Mario Monti saw the bond auction results as positive. However, the market turbulence may not be over, he said at his year-end press conference in Rome today.

The European Central Bank last week pumped a record EUR 489.191 billion into the Eurozone financial system in the first offering of its three-year loans in its latest effort to boost liquidity.

The greater take-up of the long term loans by banks boosted hopes that a credit crunch in the Eurozone can be avoided. Further, it was also expected that banks may use these funds to buy euro area sovereigns bonds, thereby helping to drive down government borrowing costs.

Also boosting investor sentiment was the parliamentary approval for the new Prime Minister Monti's austerity budget. But, the proposed plan risks worsening the economic slump in the country.

The Italian economy contracted 0.2 percent in the third quarter mainly led by a fall in domestic demand and investment, and likely entered a recession triggered by the Eurozone's deepening debt crisis.