By Dhara Ranasinghe
LONDON (Reuters) - The premium investors demand for holding Italian bonds over their German peers fell towards its lowest in more than a year on Tuesday, a day after data showed ECB bond buying continues to favor Italy and France.
The European Central Bank bought fewer German bonds than it should have for the eighth consecutive month in November, with France and Italy once again picking up the slack, data for the bank's stimulus program showed late on Monday.
France and Italy each enjoyed purchases that were nearly a billion euros above their 'capital key' at 10.439 billion euros and 9.077 billion euros. The capital key is the method by which the ECB buys government bonds for its stimulus in relation to the size of the economy of each member state.
"The latest ECB buying data underscores the flexibility of the scheme that tends to benefit the periphery," said Commerzbank (DE:CBKG) rates strategist Christoph Rieger.
Italy's 10-year government bond yield was flat around 1.71 percent in early Tuesday trade <IT10YT=TWEB>, in line with southern European peers <ES10YT=TWEB> <PT10YT=TWEB>.
The gap over benchmark German Bund yields <DE10YT=TWEB> was around 137 basis points, near around 136 hit last month that was the lowest since October 2016.
Analysts said the fact that the data also suggested the ECB was front-loading purchases ahead of the quiet year-end period, was also positive for euro zone bonds and in particular countries such as Italy.
(For graphic on ECB deviation from its capital key: http://reut.rs/2A5tp6S)
Citi said the cumulative front-loading of ECB bond buying is 10.77 billion euros, implying potentially 49.2 billion euros of net purchases in December.
To achieve that target, the weekly pace will likely have to go up to 17.2 billion euros from a November average of 14.93 billion for the next two weeks before falling to 10.3 billion euros in the third week of December, Citi analysts said.
"That implies strong support for euro zone government bonds from front-loading for two more weeks, particularly (French) OATs and (Italian) BTPs where buying has continued above the capital key and supply is light," they said in a note.
After last week's unexpected surge in a key overnight benchmark rate European banks use to lend money to each other, analysts said they would be closely watching the ECB's one-week main refinancing operation on Tuesday for any signs of distortions in the market.