MILAN (Reuters) - Italy paid its highest borrowing rate in five years in a bond auction on Thursday after its new populist government alarmed investors by tripling the budget deficit target for next year.
Some investors fear Rome is sowing the seeds of a future debt crisis by pushing ahead with costly electoral promises such as a lower retirement age and a basic income for the poor. Italy holds the world's third-largest public debt burden.
In Thursday's auction the Treasury sold a new three-year bond at a yield of 2.51 percent, the highest since September 2013, though demand for this and other issues was strong.
Public debt runs at 1.3 times economic output in Italy, a country that suffers from chronically low growth. The ruling coalition came to power in June, promising to kickstart economic growth and tackle rising poverty with higher public spending.
Despite the jump in borrowing costs, continued strong demand for Italian paper calmed fears in the market, with yields on existing bonds dipping on the auction results.
"Demand at the auction was good, though you have to remember that the size of the issue was contained and this really helped," said Luca Cazzulani, deputy head of fixed-income strategy at UniCredit.
The treasury raised 6.5 billion euros ($7.5 billion), the maximum it had set itself ahead of the auction, by issuing bonds maturing over three, seven, 15 and 30 years.
The yield on the seven-year bond at auction was a record since Italy began issuing this maturity in January 2014.
The 2019 budget plan has ignited concerns at the European Commission, and among Italy's euro zone partners, that Rome's spending could undermine the single currency.
Some independent Italian state bodies have also raised alarms. Italy's INPS says that planned pension changes would raise pension debt by about 100 billion euros while parliament's budget oversight agency says the government's economic growth forecast is overly optimistic.
The government targets a budget deficit of 2.4 percent of domestic output next year, three times the level set by the previous center-left executive.
Investors are now nervously awaiting updates on Italy's creditworthiness from rating agencies, with Standard & Poor's due to review its "BBB" rating on Oct. 26.
Moody's will decide by the end of October whether to downgrade Italy after placing its rating on review for a possible cut after the new coalition's spending plans first surfaced.
($1 = 0.8660 euros)