LONDON- Italian bond yields remained near recent lows on Monday as chances of a rapprochement with the European Union grew, but French borrowing costs rose as "yellow vest" protests rumbled on in Paris over the weekend.
Italy's coalition government has agreed on the "numbers and contents" of the budget it will propose to Brussels in a bid to avoid disciplinary action over its planned deficit spending next year, a spokeswoman for the ruling League party said on Monday.
In France, Prime Minister Edouard Philippe told the newspaper Les Echos the deficit was likely to overshoot the EU limit of 3 percent of GDP next year to around 3.2 percent.
"The focus is a bit more on France now - investors are waiting for the revision of the French deficit after the spending measures announced by Macron," said Natixis strategist Cyril Regnat.
The streets of France saw the fifth weekend of demonstrations against President Emmanuel Macron's government, and though protest groups were noticeably smaller, shops were still closed as a precaution.
Macron last week announced tax cuts for pensioners and an increase in the minimum wage, in an effort to defuse the protests.
"The net issuance target for (French) OATs next year is about 195 billion euros. If they have to increase it, then the market reaction would be even more negative," Regnat said.
Should France's budget deficit considerably breach EU budget rules, it will make it more difficult for Brussels to strong-arm Italy into compliance, said Rabobank rate strategist Matt Cairns.
"At what point do the populists (in Italy and elsewhere) point the finger back at France" he said.
French government bond yields rose a basis point to 0.72 percent, pushing the France/Germany 10-year bond yield spread up to 46 bps, near last week's 1 1/2-year high.
Italian bond yields fell at one point before reversing those price gains to trade flat on the day.
The Italy/Germany 10-year yield spread was at 269 basis points early on Monday, not far from last Thursday's 2-1/2-month low of 261 bps and well away from November's high of 326 bps.
What's particularly notable is that German yields have dropped recently on downbeat growth and inflation expectations. Ten-year yields, at 0.25 percent, are about half what they were two months ago.
However, Regnat of Natixis warned that Italy's revised budget has to go through a few more stages before receiving EU approval.
"To me it's more short-term relief at this stage and investors will be reassessing Italian risk in January," he said.
Other euro zone bond yields were mostly unchanged on Monday following the release of final euro zone inflation numbers, which showed consumer prices in the 19 countries sharing the euro eased 0.2 percent month-on-month in November for a 1.9 percent year-on-year increase. This was a revision down from the previously reported 2.0 percent.
A market gauge of long-term euro zone inflation expectations remain close to recent lows at around 1.623 percent.
(Reporting by Abhinav Ramnarayan, additional reporting by Virginia Furness, editing by Larry King, Richard Balmforth) ((Abhinav.Ramnarayan@thomsonreuters.com; 0044 777 555 1499;))
