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By Swati Pandey
SYDNEY, Sept 7 (Reuters) - Foreign holdings of Australian government bonds fell to their lowest in over five years last quarter, suggesting to analysts that either bond prices or the local dollar will have to weaken to revive appetite.
Official data released on Tuesday on financial flows showed non-residents sold A$2.4 billion ($1.84 billion) of government bonds in April-June, the first net sales in three years.
Their total holdings dropped to under 60 percent of the total debt outstanding, down from a peak of more than 75 percent in mid-2012.
The premium offered by 10-year Australian Commonwealth Government Bonds (ACGBs) over U.S. Treasuries AU10YT=RR is already the slimmest in 15 years.
That might be too small to ensure the loyalty of foreign buyers which the local market has long taken for granted, said ANZ rates strategist Katie Hill.
"The data shows that the flow into Australian securities is not unidirectional," she added. "We continue to expect a decline in foreign holdings as a percentage of the overall stock of ACGBs."
The sell-down comes at a tricky time for the Australian government which needs to borrow ever more money to fund a persistent budget deficit.
The Office of Financial Management (AOFM), the body responsible for managing government debt, is expected to issue bonds worth a total A$90 billion in the year to June 2017.
The sell-off also has implications for the Australian dollar AUD= . The Aussie is up more than 5 percent so far this year, thanks in large part to offshore interest in carry trades - where investors borrow at low rates in yen or euros to buy higher-yielding assets.
If shrinking yield spreads were to threaten that carry trade, the currency could be in for a tough time.
"With the supply (of bonds) continuing to grow we think there is a limit to how low non-resident ownership of ACGBs can go," Deutsche's macro strategist David Plank said.
"ACGBs will need to cheapen in order to attract increased demand. We don't think this cheapening will be via higher rate spreads to other markets, however. We think the needed price adjustment will occur via a weaker Australian dollar."
($1 = 1.3053 Australian dollars)