Spain steals a march over Italy by trimming debt sales
* Italy returns to market next week, Spain in September
* Spain to slow debt issuance, Italy's pace unchanged
* Spain's strategy makes its bonds more attractive near-term
* Reducing pace of debt sales may backfire in long run
LONDON, Aug 21 (Reuters) - Spain's plans to scale back monthly bond offerings, when it returns to market next month, may shrink the risk premium its debt carries over Italian bonds - at least in the near term.
The two countries, whose large debts and sheer size have put them at the forefront of the euro zone crisis, have already completed more than two-thirds of their annual funding target - a strong position to weather any new shocks this year.
Both countries have cancelled August auctions but, while Spain aims to cut monthly issuance by a third, Italy, due to sell debt next week, plans to keep up the pace.
Italy has not explained its stance. Analysts say it is raising more cash either to plug a larger-than-planned budget gap or is building buffers against a new flare-up in the crisis.
The fact that Spain is not pre-funding itself for 2014 reassures investors its budget is under control, but it is a strategy that could backfire later, analysts said.
In any case, the reduced supply pressure from Spain makes its bonds more attractive near-term. Since Spain made its plans public last week, its 10-year bond yield premium over Italy has halved to 15 basis points.
Bayerische Landesbank chief strategist Marius Daheim said the prevailing market view was for this trend to continue and "I wouldn't put myself against it".
Spain, which has met 76 percent of its 121 billion euros annual target for bond sales, must sell an average of 2.9 billion at each of its 10 sales scheduled until mid-January to meet its goal, down from around 4 billion on average so far.
Italy has met 71 percent of an annual target of 450 billion euros, which also includes short-term Treasury bills. It is estimated to have met around 80 percent of its bond sales plan.
However, Italy has said it will pay 20 billion euros or more in overdue bills to credit-starved domestic companies by the end of the year, with another 20 billion earmarked for 2014. It is also debating whether to scrap an unpopular property tax.
Both countries' yield premia over benchmark German debt stand at two-year lows, having fallen on the back of upbeat economic data and the seasonal break in debt issuance.
The spreads could re-widen slightly once supply resumes, but hefty debt and coupon repayments to investors later this year - a combined 88 billion euros, according to Reuters data - should prevent a sustained reversal of the trend, analysts said.
"We might see some supply pressure, but the rally can go forward," Commerzbank rate strategist Michael Leister said.
TAKING A RISK
Slowing debt sales may cap Spain's borrowing costs now, but may leave it more vulnerable later, with analysts pointing to risks such as the instability of Italy's government or Greece's and Portugal's struggles to exit their bailouts.
If such risks materialise, and Italy has pre-funded while Spain has not, Spanish yields would be under greater pressure.
Any sell-off in those markets worries investors given that at the height of the crisis in 2011-12, both countries' borrowing costs hit unsustainable levels above 7 percent.
"I'd be (issuing) as much as I could get away with. They are well ahead for this year but I'd be looking forward to the next year," ICAP strategist Philip Tyson said.
"If those countries scale back they may find that they encounter some problems going forward if ... tensions in the euro zone crisis pop out again."
Tyson said a key risk was that the European Central Bank - whose crisis loans and bond-buying promise gave Italy and Spain breathing space to frontload debt issuance in 2012 and 2013 - is unlikely to introduce new extraordinary measures next year as the euro zone economy shows signs of recovery.
An ECB promise to buy the bonds of troubled countries that ask for financial support still stands, however, and the bank's promise to keep interest rates low for a long period makes high-yielding debt attractive.
These existing safety nets mean investors remain sanguine, even about Spain's relaxed debt issuance plans.
"At the end of the day they have always been able to sell paper. At what price is another question but even in stress periods they were able to sell," Commerzbank's Leister said.
(Editing by Nigel Stephenson and Stephen Nisbet)