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Italy's Debt Costs to Rise at Auction in Wake of Fitch Downgrade

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Italy's borrowing costs will climb on Wednesday at its first sale of long-term debt since Fitch cut its credit rating, but demand for high yields and European Central Bank protection will temper the rise, analysts said.

Rome will offer up to 7.25 billion euros ($9.4 billion) in four different bonds, including three- and 15-year paper.

Rating agency Fitch cut Italy to within three notches of 'junk' status last Friday and left it on a negative outlook, citing political uncertainty after an inconclusive election, deep recession and the country's rising debt.

The downgrade drove Italy's one-year borrowing costs up roughly 20 basis points at auction on Tuesday to their highest since December, but demand was also high.

(Read More: ECB, Global Recovery Behind Markets' Mercy on Italy)

Analysts expect a similar result at Wednesday's auction.

"They may have to pay an uptick of 15-20 basis points on the three-year bond and 10 basis points on the 15-year compared with previous sales," said Chiara Cremonesi, fixed income strategist at UniCredit.

The rise in Italian yields contrasts sharply with a fall in those in Spain, which announced a special triple bond auction on Tuesday after its one-year debt costs hit their lowest level since the Greek debt meltdown in 2010.

Italy and Spain, the euro zone's third- and fourth-largest economies, have been under intense scrutiny amid fears a prolonged economic slump and high public and private debts in southern Europe are unsustainable.

Still, Cremonesi said demand for Italian debt has been solid despite the stalemate in the wake of the election, which produced a hung parliament.

(Read More: Why Italy Could Be the Next 'Bad Boy of Europe')

Wednesday's sale also marks the debut for the new 15-year bond at a regular auction, after it was launched through a syndicated sale in mid-January. Bankers have said the issue is likely to be attractive to long-term investors such as insurers and pension funds.

The three-year bond was sold with a yield of 2.30 percent at a mid-February auction, while the 15-year paid a return of 4.81 percent when it was issued on Jan. 15.

"We expect a good result for the sale of the bond maturing September 2028 as demand for this bond is very strong and the bond is still 'special' in the repo market," Cremonesi said.

Foreign insurers are attracted by this bond because of its maturity, while the European Central Bank's pledge to underpin the euro zone continues to support the bond market, a trader at an Italian bank said.

"There are few issues on this segment of the yield curve for euro-denominated debt, while demand coming from institutional investors is quite strong," the trader added.

"The Italian debt market is supported by the European Central Bank's bond buying program, heavy liquidity and the expectations that interest rates will remain low in the near future in the euro zone," said the trader.

(Read More: Grillo's Party to Tell Italy President it Can Lead Government)

The February 24-25 election left parliament with a center-left coalition in charge of the lower house but lacking control of the upper house, which has equal legislative powers.

The anti-establishment 5-Star Movement led by comedian-turned-politician Beppe Grillo holds the balance of power but says it will not ally itself with either of the main center-left or center-right blocs.

If a government cannot be formed, the country could find itself heading for fresh elections within a few months.

Contact Europe: Economy

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