Italy’s two-year yields hit highest in 3-1/2 years at…

MILAN, May 28 (Reuters) – Italy’s unfolding political crisis pushed its cost of borrowing over two years to the highest level since December 2014 at an auction on Monday.

Italy placed the top planned amount of 1.75 billion euros ($2 billion) of a zero-coupon bond maturing in March 2020 at a gross 0.35 percent yield, up from a negative yield of minus 0.275 at the previous auction in late April.

Italian bonds rallied early on Monday after the Italian president’s vetoing of a eurosceptic economy minister picked by the 5-Star Movement and the League prevented the two anti-establishment parties from forming a government.

But the market reprieve proved short-lived and analysts warn about further pressure ahead as the country will face fresh elections if — as expected — a technocrat government that could be formed does not win parliamentary backing.

“Italian uncertainties will continue to weigh heavily on sentiment,” Berenberg Chief Economist Holger Schmieding said.

“In new elections, the radicals will likely rail even more loudly than before against Italy’s pro-European ‘establishment’ and an alleged ‘German hegemony’ exercised through the rulebook of the single currency.”

At Monday’s auction, Italy also placed a combined 1.25 billion euros of two inflation-linked bonds maturing in May 2022 and May 2028, meeting the top of its targeted issuance range.

The May 2022 BTPei bond fetched a gross negative yield of minus 0.05 percent. It had last been sold in February at minus 0.41 percent.

Italy paid 1.28 percent to place the May 2028 linker up from 0.47 percent when it last auctioned it a month ago.

The Treasury will sell six-month bills on Tuesday and up to 6 billion euros in bonds on Wednesday, including 5- and 10-year nominal bonds as well as a seven-year floating-rate one. ($1 = 0.8568 euros) (Reporting by Valentina Za; Editing by Catherine Evans)