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'Uneasy Calm' in Euro Zone Bonds Could Be Over

Martin Oeser | DDP | Getty Images

Investor attention may be firmly focused on rising bond yields in major economies, but Europe's peripheral bond yields rose once again on Wednesday with Italy having to pay much more in an auction of 12-month bonds.

Italy's 12-month borrowing costs rose on Wednesday when the Italian treasury sold 7 billion euros of 12-month bills at a yield of 0.962 percent. A previous auction on May 10 saw 12-month debt sold at an average 0.703 percent, a euro era low for Italy.

Though peripheral bond markets have experienced an unusual calm in the last few months, analysts told CNBC they won't escape increasing market volatility.

Investor concerns about the scaling back of monetary stimulus by the U.S. Federal Reserve have continued to weigh on financial markets this week leading to a major sell-off in risk assets and bond markets.

Euro zone peripheral yields stabilized on Wednesday morning after rising on Tuesday with Greek 10-year rates up 63 basis points (bps) to 10.22 percent. Likewise, Portuguese 10-year yields rose 34 bps to 6.59 percent while Italian and Spanish 10-year yields rose 7 bps to 4.34 percent and 4.66 percent respectively.

(Read More: US Government Forced to Pay Real Rates on Debt)

"The tide has turned for euro zone peripheral debt," Nicholas Spiro, head of Sprio Sovereign Strategy, told CNBC on Wednesday. "Over the last several months, markets have been at pains to identify catalysts for yields to rise significantly. Now it's difficult to paint a scenario for them not to."

It's not so long ago that sovereign bond yields in Italy and Spain were at their lowest levels since the winter of 2010. Bond yields declined in late April and early May, despite the still recent bailout in Cyprus which signalled that the euro zone crisis was far from over, the chief European economist at HSBC said in a note on Tuesday.

"A sense of calm has pervaded the peripheral bond markets lately…However, the rise in global bond yields and volatility over the past month, which has also driven a rise in peripheral yields, reminds us that fundamentals could soon start to matter again," HSBC's Janet Henry said.

(Read More- Italian Bond Yields Could Be Poised on Precipice)

"Currently, the periphery's are far from sound. Growth is still not coming back, unemployment rates are rising to socially unacceptable levels and debt projections continue to be revised up. This economic reality suggests financial markets may abruptly wake up from a somewhat complacent mood. The calm, such as it is, is an uneasy one," she added.

(Read More- Europe Markets That May Be Worth Snapping Up)

Another acknowledgement of weaker growth in the periphery came from Barclays on Tuesday when it downgraded Italy's growth forecasts for 2013 and 2014 on account of a weaker-than-previously projected domestic demand. The bank forecast GDP will contract 1.7 percent this year and expand 0.8 percent in 2014, that was down from previous expectations of a contraction of 1.5 percent in 2013 and 1 percent increase in 2014.

In a research note published on Tuesday, Willem Buiter, chief European economist at Citi warned that sovereign debt was on an unsustainable trajectory in Cyprus, Greece, Ireland, Italy, Portugal, and Spain.

(Read More: Pimco Sees 60% Chance of Global Recession in 3-5 Years)

"For now, credit risk premia for euro area (EA) sovereign bonds have fallen markedly and political leaders in the EA maintain that sovereign debt restructuring outside of Greece (and possibly Cyprus) is neither necessary nor desirable in other EA periphery countries. But persistent economic weakness and gradual, limited policy support (fiscal, financial and monetary) to fiscally weak EA countries leave the public finances on an unsustainable trajectory in a number of EA countries."

Citi expects some form of debt restructuring for up to seven euro area counties including Cyprus, Greece, Ireland, Italy, Portugal, Slovenia, and Spain by 2017.

- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt

Contact Europe: Economy

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