LONDON/PARIS (MNI) – Spreads on Italian government debt widened
Thursday after a lackluster auction of 3-, 7-, and 10-year bonds left
markets disappointed — especially following a sale of shorter-date
securities on Wednesday that had temporarily lifted spirits.

Today’s average yield on the 3-year 2014 BTP was significantly
lower than the last time it was sold, but demand was weaker. And while
the average yield on Italy’s Mar 2022 BTP fell compared with the last
auction a month ago, it was still in the red-flag zone, just barely
under 7%.

In reaction, the spread on 10-year Italian bonds in the secondary
market widened after the auction by 14 basis points to 520 above the
benchmark German Bund, before easing back slightly to +516 bp. It last
yielded around 7.06% — a figure that puts borrowing costs for the
Italian government at a level many analysts consider to be unsustainable
over the medium- and long-term.

The market reaction today was in sharp contrast to Wednesday, when
the 10-year bond yield dropped 25 basis points to 6.75% after a very
successful auction of 2-year bonds and six-month bills that was widely
interpreted as good news for the government in Rome.

At yesterday’s auction, yields on the 2-year zero coupon bonds
averaged 4.85%, down sharply from 7.81% last month. Yields on the bills
were halved to just 3.25% from 6.5% in November. Demand for both issues
was also higher, with bid-cover ratios rising.

Today’s sale, by contrast, was clearly a much tougher challenge for
Italy, in large part because of the longer maturities. The
less-than-stellar result, combined with signs that banks are still
hoarding their cash rather than lending it, is likely to raise questions
about whether the European Central Bank’s massive three-year refinancing
operation earlier this month will succeed at unlocking balance sheets
and avoid a looming credit crunch.

The ECB doled out a record E489.2 billion in three-year loans on
December 21 at an interest rate of 1%. Yet so far, banks have only
parked that cash right back at the ECB – in the overnight deposit
facility, which is paying just 0.25%.

That banks are willing take a loss on that money would seem to
attest to an ongoing crisis of confidence in the interbank market, and
could be a negative omen for the success of the ECB policy, which is
intended to unlock banks’ balance sheets and jump start lending to
households and businesses. Some analysts – and political leaders,
including French President Nicolas Sarkozy – had also hoped the new
flood of cheap, long-term ECB cash would help alleviate tensions in
sovereign bond markets, especially Italy’s.

Banks parked a whopping E436.6 billion in the ECB deposit facility
on Wednesday. That was down from a record E452 billion the day before,
but it still represents the vast majority of the 3-year funds borrowed
by banks last week. Some analysts, taking a more sanguine view, say
banks may just be building up cash reserves for end-of-year book
squaring purposes.

It is probably too early to tell whether the ECB’s new liquidity
spigot is having the desired effect. After the New Year, it will be
important to see how much of that money stays at the ECB deposit
facility. Also of great significance as 2012 enters will be a series of
sovereign debt auctions, especially by Italy, which will seek to raise
about E100 billion in the first quarter alone.

At today’s auction of four different securities, Italy sold a total
E7.017 billion, well within the range of E5 to E8.5 billion it had hoped
for.

The Italian Treasury sold E2.538 billion of its 6.00% 2014 BTP, in
the middle of the desired E2.0 to E3.0 billion range. The average yield
fell to 5.62% from 7.89% on November 29. But the bid-cover ratio was
just 1.3654, down from 1.5 a month ago.

Italy also sold E2.5 billion worth of 5% 2022 BTPs, at the top end
of the range it had hoped for. But the average yield of 6.98%, while
down from 7.56% at the November 29 auction, was uncomfortably close to
the 7% level. The bid-cover was weakish, at 1.357, only marginally
higher than a month ago.

The treasury sold E1.176 billion worth of its off-the-run 4.75% Sep
2021 BTP, near the bottom end of the E1 to E2 billion range. The average
yield, at 6.70%, was also uncomfortably high.

Italy also auctioned off E803 million of its 7-year floater Apr
2018 CCTeu, solidly in the middle of the E500 million to E1 billion
range. However, the average yield was way into the danger zone at 7.42%.

The 2021 BTP was last sold on October 13 and the 2018 CCTeu on
August 30, so those sales are not comparable to today’s results.

Italy has now sold E208.76 billion worth of bonds this year,
according to Market News International calculations compared to its
planned target of E220 billion to E230 billion.

–London newsroom: 00 44 20 7862 7494; email: nshamim@marketnews.com
–Paris newsroom: +331-42-71-55-40; email: bwolfson@marketnews.com

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