Italy raises $14 billion at much lower cost (AP)

ROME ? Strong demand for short-term Italian government debt on Wednesday pushed the country's borrowing costs lower and suggested investors have become less jittery about an imminent default by the eurozone's third-largest economy.

Italy raised euro10.7 billion ($14 billion) in a pair of auctions at sharply lower rates than those it was forced to pay just a month ago when investor concerns over the ability of the country to service its massive debts became particularly acute and effectively prompted a change in government.

The sharp decline in Italy's borrowing costs could be a signal that commercial banks from the 17 countries that use the euro diverted some of the money they tapped from emergency loans from the European Central Bank last week to buy the bonds of heavily indebted governments. It may also suggest rising investor confidence in Italy's recent efforts to reduce its long-term debt through a variety of austerity measures.

The Bank of Italy said the average yield on its euro9 billion ($11.8 billion) six-month bill offering was 3.251 percent, half the 6.504 percent rate it had to pay at the equivalent auction last month. And an auction of two-year bonds, which raised euro1.7 billion ($2.2 billion), also saw the yield fall to 4.853 percent from 7.814 percent last month.

"This is an encouraging development, suggesting that the Italian sovereign debt market has pulled back from the dangerous situation in late November," said Raj Badiani, a senior economist at IHS Global Insight.

"The calmer environment reflects the passing of additional austerity measures and some welcome progress on the structural reform agenda, coupled with the ECB's decision to provide additional cheap financing to Italian banks," Badiani added.

After initially cheering the auction results, sentiment in markets deteriorated sharply in risk-averse trading following a weaker than anticipated performance on Wall Street.

While Italy's FTSE MIB fell in line with other stock markets, the euro slid to $1.2938, its lowest level since Jan. 11 and the yield on Italy's benchmark ten-year bonds pushed back towards the 7 percent mark that is widely considered to be unsustainable in the long-run. Further insights into the level of demand for Italy's ten-year bonds will emerge in an auction Thursday.

Italy is the eurozone's third-largest economy and is considered too big to save under the eurozone's current bailout funds. Markets have grown fearful over the past few months that Italy will find it difficult to pay off its massive debts, which stand at around euro1.9 trillion ($2.5 trillion). Next year alone, Italy has some euro330 billion ($431 billion) of debt to refinance.

Mario Monti, the country's new premier, got parliamentary approval last week for more spending cuts and tax increases intended to save the country from financial disaster. One of the most controversial aspects of the austerity package is reform of Italy's bloated pension system.

As well as possibly indicating increased confidence that Monti's efforts will keep the country's finances on a sustainable path, Wednesday's auctions could also have been supported as well by a large infusion of credit to eurozone banks last week from the European Central Bank. A week ago, 523 banks took the opportunity to swell their coffers by euro489 billion ($639 billion), the largest ECB loan operation in the 13-year history of the euro.

There has been speculation that the stronger banks might use the cheap, long-term loans ? on which the current interest rate is 1 percent ? to purchase government bonds that carry higher interest rates and profit from the difference.

That could support both government and bank finances. But it would run contrary to efforts by many banks to lower their exposure to bonds issued by heavily indebted governments.

While some banks may be using the money they got from the ECB to buy up government debt, many others appear to have opted for a much safer option ? depositing their new cash back with the central bank. Figures Wednesday showed eurozone banks parked a record euro452 billon ($591 billion) overnight at the bank Tuesday, surpassing the previous record of euro411.80 billion set only Monday.

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AP Business Writer David McHugh contributed from Frankfurt, Germany.

Source: http://us.rd.yahoo.com/dailynews/rss/eurobiz/*http%3A//news.yahoo.com/s/ap/20111228/ap_on_bi_ge/eu_italy_financial_crisis

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