Government bonds boosted by unease over Italian bank rescue plan

By Abhinav Ramnarayan

LONDON (Reuters) - Euro zone bond yields fell across the board on Wednesday as concerns about the strength of a rescue plan for Italian banks pushed investors to the safety of government debt.

Germany's 10-year yields hit their lowest in seven weeks and other euro zone equivalents were also in demand.

On Monday, the European Central Bank told ailing Italian lender Monte dei Paschi di Siena that its capital shortfall had risen to 8.8 billion euros ($9.2 billion), from 5 billion euros indicated previously.

This raised questions about whether the 20 billion euros earmarked by the Italian government would be enough to cover the funding requirements of all the country's banks.

An Italian Treasury source told Reuters this week that the amount would be enough, but investors are still concerned, said DZ Bank strategist Andy Cossor.

"The latest news about the Italian banking system may well be pushing investors into the safe haven of the Bund market," he said.

"It is not an insignificant factor, because the Italian government is putting aside 20 billion euros and there are questions marks over whether this will be enough. The market would like to have some clarity on this subject."

Germany's 10-year bond yield hit 0.18 percent in early trades, the lowest since Nov. 9, down 1 basis point on the day.

"Also, good quality safe haven assets are usually in demand at the year end - investors want to close their books with some safe assets in them," said Cossor.

The broad rally in euro zone government debt also boosted Italian bonds. Ten-year yields fell 2 bps to 1.81 percent, reversing losses from earlier in the week.

Highlighting the divergence between the U.S. and Europe, 10-year U.S. Treasury yields rose overnight to 2.56 percent after U.S. consumer confidence hit its highest level in more than 15 years in December.

The gap between benchmark German and U.S. yields hit a high of 237 bps on Wednesday. The spread has been increasing recently on the divergence between European and U.S. central bank policy and outlooks for growth and inflation.

For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

($1 = 0.9578 euros)

(Reporting by Abhinav Ramnarayan; editing by John Stonestreet)