Borrowing costs in Italy soared on Monday, and premium investor demand to hold Italian debt over safer German counterparts was the highest in a month as political turmoil in Italy continued.
Prime Minister Mario Draghi was set to step down after coalition partner 5-Star Movement failed to support his vote of confidence. The President of Italy rejected Draghi’s resignation.
According to sources from the office, Draghi is determined to step down from his post.
Italy’s 10-year yield rose 10 basis points to 3.48% in early trading, pushing the German bond yield spread to its highest level in a month at around 235 basis points.
The two-year bond yield rose almost 4 basis points to 1.36%.
Eurozone bond yields were higher, but the gains were especially noticeable in Italy. The yield of German 10-year bonds rose by 6 basis points.
Draghi is due to address parliament on Wednesday.
“We expect volatility to remain high until then in response to various rumours concerning whether he will remain firm on his resignation or whether he is willing to remain in place,” UniCredit analysts said in a note.
“Any indication that could increase the likelihood of early elections will ultimately be negative for BTPs and drive the spread wider.”
Political instability in Italy comes as the European Central Bank (ECB) is expected to raise interest rates for the first time in 11 years and announce details of a new anti-fragmentation tool to contain the impact on bond markets.
The ECB has already noted a 25 basis point rate hike this Thursday, and there is about a 35% chance of a sharp 50 basis point hike in the money markets.
The market price will tighten by 160 basis points by the end of the year, which suggests that a 50 basis point increase could occur at one or more of the next ECB meetings.
“The window is closing rapidly, and I think this is what we see in terms of market pricing,” said Tatjana Greil-Castro, co-head of public markets and portfolio manager at Muzinich & Co.
“We struggle to see what’s going to happen in September – so many things can happen from here to there right now.”
The eurozone is grappling with a coming energy crisis that has raised the risk of a recession.
Subscribe for our newsletter
Get Forex brokers reviews, market insights, expert analytics and education material right into your inbox for free!