(Bloomberg) -- A key gauge of Italian bond-market pressure could surpass this year’s peak as the nation’s political ructions mute the impact of European Central Bank debt purchases that favor southern Europe.
The extra yield investors demand to hold Italian 10-year notes over German debt is almost 25 basis points off the high in June of 244. But with right-wing parties on track for a landslide victory in September, strategists at Jefferies International and UniCredit Bank see the premium climbing to 250 basis points later this year.
The fact that the spread remained elevated even as the ECB ramped up support through targeted reinvestments suggests there was more selling pressure than the yield-move alone implies. That hints at the battle to come as ECB President Christine Lagarde tries to keep borrowing costs from diverging wildly among EU member states, while hiking rates to tame surging inflation.
Outside Italian politics, bond markets were “orderly” in July and the ECB was “trigger-happy” to wade into EU periphery debt, Christoph Rieger, head of rates and credit research at Commerzbank AG, wrote in a note to clients.
“Against this backdrop, it is even more remarkable that BTP spreads widened close to their highs during July, despite the ECB support,” said Rieger, who predicts the gap between Italian and German yields will reach 240 basis points later in the year.
ECB bond data illustrate the tilt south. Net holdings of German, French and Dutch bonds dropped by 18.9 billion euros ($19.3 billion) through July, according to figures available on a two-month basis that were published Tuesday. Net purchases of debt from Italy, Spain, Portugal and Greece, meanwhile, totaled 17.3 billion euros.
Read more: ECB Spent Billions to Shield Italy Using First Line of Defense
While the reinvestments may help absorb shocks, UniCredit predicts more gyrations to come for Italian bonds as the election campaign gets increasingly raucous.
“Episodes of spread widening above 250 basis points are possible,” strategists including Luca Cazzulani wrote in a note.
“We think investors will want to gather enough evidence that the new government will stick to its commitments in terms of reform and fiscal policy before increasing exposure to BTPs.”
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