Italy's borrowing costs at smallest premium to France since 2007

By Stefano Rebaudo

Aug 14 (Reuters) - The premium that investors want to lend money to Italy rather than to France reached its smallest in almost 18 years on Thursday, underscoring the growing concerns over the outlook for French government finances.

The gap between the yield on 10-year Italian government bonds, or BTPs IT10YT-RR and that on French 10-year OATs reached 14.5 basis points (bps), its smallest since the end of 2007, according to LSEG data.

French bond yields, which reflect the cost to the government for borrowing over the longer term, have risen by 18 bps while Italian borrowing costs were roughly unchanged.

Analysts say political uncertainty could weigh on French debt and the upcoming budgetary debates in parliament after the summer break could intensify investor scrutiny.

French Prime Minister Francois Bayrou must persuade the opposition ranks in a fractured parliament to at least tolerate his cuts, or risk facing a no-confidence motion like the one that toppled his predecessor in December.

Citi sees OATs underperforming versus other European bonds, ahead of the French parliament returning from its summer recess on September 22. They note that positioning among investors just a few weeks ago was fairly flat, suggesting there was little bearish sentiment towards France.

The French government intends to target a budget deficit of 4.6% of gross domestic product (GDP) for 2026, but consensus is already looking for a deficit slippage to 5.2% of GDP.

Some investors think that with the European Central Bank easing cycle close to an end there will probably be less room after the summer for Italian BTP yields to catch up much more with those of benchmark Bunds, which also affects France's risk premium.

Analysts also point to a structural shift in euro area yield spreads, as doubts persist over the safe-haven status of U.S. Treasuries and Germany prepares for a major increase in government borrowing and spending, which could push yields on both higher.

“Europe looks like the sweet spot for investors which are increasingly more cautious about U.S. Treasuries,” said Michiel Tukker, rate strategist at ING.

“Bunds are obviously the sweet spot, but also European government bonds are benefiting significantly from potential foreign demand,” he added.