UPDATE 1-Italy 2-yr debt costs hit five-month low at auction

Valentina Za
Monday, 28 Oct 2013 | 7:59 AM ET

(adds analyst comments, details)

MILAN, Oct 28 (Reuters) - Italy's two-year yields hit their lowest level since May at an auction of zero-coupon bonds on Monday as expectations of abundant liquidity both in Europe and the United States supported shorter maturities.

Italy sold 2.25 billion euros of its June 2015 zero-coupon bond with demand 1.8 times that amount, in line with a previous auction in late September. The yield fell to 1.39 percent from 1.62 percent.

Expectations that the U.S. central bank will hold off on scaling back its monetary stimulus until next year are feeding appetite for bonds, analysts say. Shorter maturities also draw support from the perceived possibility of another round of cheap longer-term loans to banks from the European Central Bank.

"Two-year yields have declined 25 basis points since the last auction. However, we see room for further decline," analysts at UniCredit said in a note.

"We continue to expect the ECB to launch another longer-term refinancing operation and...the delay in Fed tapering has offered tremendous support to the euro."

Italy also sold 750 million euros of an inflation-linked bond maturing in September 2023 on Monday, raising the top planned amount of 3.0 billion euros at the auction overall.

The benign market backdrop has helped offset concerns over Italy's chronic political instability and analysts expect this week's other two Italian auctions to go smoothly, supported by nearly 24 billion euros of redemption flows.

Rome offers 8 billion euros of six-month bills on Tuesday and up to 6 billion euros of five and 10-year bonds on Wednesday.

"Investors are not paying much attention to political noises," ING strategist Alessandro Giansanti said.

A looming Senate vote over whether to expel former prime minister Silvio Berlusconi from parliament and rifts shaking his centre-right party are aggravating tensions in Prime Minister Enrico Letta's wobbly left-right coalition government.

In its push to meet a gross funding target of around 470 billion euros for the year, Italy's Treasury will next week also launch a new four-year bond linked to domestic inflation and targeted at retail investors.

On Monday, the inflation-linked bond fetched a yield of 2.73 percent, compared with 3.3 percent at the previous sale in August.

The Treasury has met around 85 percent of its annual issuance target.

(Reporting by Valentina Za, editing by Silvia Aloisi and Barry Moody)