By Abhinav Ramnarayan
LONDON (Reuters) - Irish government bond yield spreads over Germany neared their widest level since late May on Monday as worries over the economic impact of a possible messy Brexit hurt demand for Irish debt.
British Prime Minister Theresa May last week disclosed a draft agreement on leaving the European Union that met with strong opposition from within her party, that could spark a confidence vote in her leadership and increases the chances of a "no deal" Brexit.
Britain is one of Ireland's biggest trading partners, and the border between Northern Ireland and the Republic of Ireland is a key issue in Brexit talks.
"A no-deal Brexit could have an adverse impact on Ireland's economic picture, which would impact risk assets and have some effect on government bonds as well," said Commerzbank (DE:CBKG) rates strategist Rainer Guntermann.
"It could affect the country in general, it could impact the budget position, the deficit position, and generally weigh on risk assets as well."
While government bonds are generally not considered risky assets, euro zone government debt - especially lower-rated debt - often tends to perform differently, since individual countries don't have control over printing money.
So while British Gilt yields dropped in reaction to the draft Brexit proposal, Irish yields increased, with 10-year yields hitting a one-month high of 1.045 percent on Friday. (IE10YT=RR)
The spread between Irish and German 10-year bond yields hit a 5-1/2-month high of 65.5 basis points after the official close on Friday, and stood at 63 bps on Monday. (DE10IE10=RR)
Any Brexit impact on effect on Ireland's economy could hurt Dublin's credit-worthiness in the long term. Ireland is currently rated A2, A+ and A+ by the three main ratings agencies Moody's, S&P Global (NYSE:SPGI) and Fitch respectively.
Moody's last reviewed Ireland in early October, leaving the rating unchanged, while S&P Global is due to review Ireland's credit rating on November 30 and Fitch on December 14.
German bonds have seen flight-to-safety demand, increasing many spreads across the euro zone, but Ireland's underperformance stands out.
For example, the Irish 10-year bond yield's spread over its closest peer, Belgium (BE10YT=RR), also reached its widest level since late May on Friday at 23.5 bps, and was at 21 bps in early trade on Monday.
Also, Irish CDS prices - the cost of insuring exposure to Ireland's sovereign debt - rose on Monday to the highest since June 2017.
Elsewhere, trade in Italian government bonds remained volatile.
After falling earlier in the day, Italian yields rose after Economy Minister Giovanni Tria said Italy was continuing discussions with the European Commission on its contested 2019 budget, but the government had no intention of changing its plans.
"One headline that stood out was that he (Tria) said it's hard to reach approval on the budget soon, which means more uncertainty," said Pascal Segesser, fixed income research analyst at DZ Bank.
Italy's 10-year bond rose 9 bps to 3.58 percent (IT10YT=RR), its highest in over three weeks, pushing the gap over German Bund yields to 320 bps (DE10YT=RR).
In late trade, German 10-year yields, were steady at 0.37 percent.