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Italian govt bonds falter after reports of PM threat to resign

Virginia Furness

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr

LONDON, June 3 (Reuters) - Italian government bonds underperformed on Monday despite assurances from its economy minister that the government can reach a compromise with Brussels and avoid sanctions over its deteriorating finances.

Elsewhere, a rally in safe haven assets is keeping German bund yields close to the all-time lows hit last week as investors focus on turmoil at the heart of Germany's government, and the continuing U.S. trade disputes with China and Mexico.

Italy's government bond yields rose four basis points across the curve in early European trade as its economy minister sought to reassure investors that Italy will obey EU fiscal rules amid rising debt, and that a compromise could be met.

Italian bond yields rose sharply last week after the European Commission wrote to Italy last week asking for an explanation as to why public debt rose in 2018 instead of falling as required.

Responding to the letter from the EU Commission, Italy vowed to respect the European Union's fiscal rules in its next budget despite deteriorating public finances and a pledge by the anti-austerity government for swingeing tax cuts.

Italian Prime Minister Giuseppe Conte is also expected to put pressure on the ruling coalition, and will present an ultimatum to fractious ruling parties on Monday to speed up government action or face his resignation, Italian newspapers La Repubblica and Il Corriere della Sera reported.

Italian 10-year bond yields rose for the third trading day in a row and were last up almost two basis points to 2.685% .

It is now just over a year since the May 29 sell-off following the appointment of an interim president and calls for snap elections amid political turmoil in the country, which saw Italian bonds suffer their worse day in more than 25 years.

Germany's 10-year government bond yield held close to the all-time lows hit last week after Andrea Nahles, leader of Germany's Social Democrats (SPD) said she would resign after the lacklustre support for her party in last week's European Elections. It was last seen at -0.20%.

The move throws doubt on the durability of Chancellor Angela Merkel's ruling coalition with the centre-left party. SPD is a junior coalition partner in Merkel's ruling alliance. Voters turned away from mainstream political parties across Europe last week.

"The deepening leadership crisis in Germany's centre-left SPD accentuates the risk that the party may walk out of the coalition with the centre-right CDU/CSU later this year," wrote Berenberg chief economist Holger Schmieding in a note on Monday. That would spell the premature end of Angela Merkel's reign as chancellor. We see a 40% probability of that."

Euro zone bond yields sank to new lows last week after U.S. President Donald Trump's sudden threat to impose tariffs on Mexican goods sent shock waves through world markets and heightened fears of a global recession.

(Reporting by Virginia Furness; additional reporting by Giselda Vagnoni in ROME, Editing by William Maclean)