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More signs of rumblings in the eurozone bond markets.

With investors starting to demand the highest premium in three years to hold French over German government bonds, the yield gap between Italy and Spain is also at its highest level since the depths of the eurozone’s debt crisis.

Diverging political and economic fortunes in the eurozone’s southern economies have sent Italy’s 10-year yield spread with Spain to over 60 basis points – the widest since 2012 (see chart above).

While Spain, the eurozone’s fourth largest economy, ended the year as the fastest growing of the bloc’s four big member states, Italy continues to lumber under swelling debt, crippled banks, and rising unemployment.

The peripheral bond market moves are the latest sign that investors are beginning to differentiate between the riskiness of debt of the eurozone’s biggest governments in a key year of elections in the single currency area.

Government bond yields and intra-eurozone spreads had been driven to record lows after the European Central Bank unleashed its record stimulus measures back in March 2015.

But investors are poised for a series of crunch political events, starting with French elections in late April and early May. Italy could also be heading for elections this summer, to replace a caretaker government that has been in office since late December.

Any flare up in political risk would also be coupled with accelerating inflation across the eurozone, which makes bonds a less attractive prospect for investors.

Copyright The Financial Times Limited 2017. All rights reserved.
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