LONDON (Reuters) - Italian bond yields edged lower on Tuesday after political sources said former premier Silvio Berlusconi was likely to step back from moves to bring down the government.
Italian 10-year bonds traded nearly on a par with their Spanish equivalents after underperforming last week on threats by Berlusconi allies to pull out of the government if he is expelled from Senate following his tax fraud conviction.
Berlusconi is expected to state his support for the government in a video message on Tuesday.
Investors' reluctance to make major shifts in positioning before a two-day Federal Reserve meeting at which the U.S. central bank is set to start withdrawing its massive monetary stimulus is likely to limit the fall in yields, however.
With a Senate committee expected to vote on Wednesday to reject attempts to prevent Berlusconi's ejection from parliament, some political uncertainty also lingers.
"For a very short-term you can see a positive reaction in the market but I would wait," KBC rate strategist Mathias van der Jeugt said. "Everybody knows he (Berlusconi) can flip-flop with his statements."
Italian 10-year yields fell 3.7 basis points on the day to 4.435 percent. The equivalent Spanish yields were 1 bps lower at 4.42 percent.
Safe-haven Bunds fell after data showed the ZEW German economic sentiment survey for September rose to 49.6 from 42.0 in August, significantly above the 46.0 consensus forecast.
Bund futures were last 19 ticks lower on the day at 138.31, having traded as low as 138.17 just after the ZEW release. Cash 10-year yields rose 2.5 basis points to 1.903 percent.
Analysts said the ZEW surprise would have had a stronger impact on Bunds had it not been for investors' reluctance to alter their asset allocations before the Fed meeting.
Reuters' latest polling of analysts has predicted the Federal Reserve will cut back its $85 billion of monthly asset purchases by $10 billion on Wednesday, less than the $15 billion cut foreseen in an August survey.
Bar any knee-jerk reaction immediately after the meeting, some traders said global bond yields are likely to keep rising as the move marks the beginning of the end for the ultra-easy monetary policy employed by many central banks since 2008.
"The market is fairly short Bunds, (U.S.) Treasuries and (UK) gilts going into the meeting, but positioning is not excessive," one trader said. "The only thing that will make the market rally will be no tapering at all."
At the other end of the credit spectrum, junk-rated Portuguese bonds were stable after taking a hammering last week due to concerns over Lisbon's relationship with its international creditors.
The head of the Eurogroup of finance ministers, Jeroen Dijsselbloem, has rejected Portuguese calls for a softening of the fiscal targets in its bailout deal. A mission of the European Union and the International Monetary Fund is in Lisbon reviewing its progress in meeting the terms of their loans.
"They will probably say at the end that Portugal has been making efforts in implementing reforms, but further steps are required," BNP Paribas rate strategist Patrick Jacq said.
"I don't think Portuguese bonds are going to recover too much in the near term."
Ten-year Portuguese yields were up 2 bps at 7.33 percent, about a full point higher than a month ago.
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