By Abhinav Ramnarayan
LONDON (Reuters) - Italy's borrowing costs dropped sharply on Wednesday after its new European Union Affairs Minister Paolo Savona said the euro was "indispensable", helping to bolster demand at a government bond auction.
The country sold 5.63 billion euros of bonds against a planned issuance range of 4.25-5.75 billion euros, though the borrowing costs were still the highest since before the European Central Bank began its 2.55 trillion euro bond-buying scheme.
Savona has previously expressed hostile views on the euro, and the 81-year-old's proposed appointment as economy minister for the anti-establishment coalition last month provoked a market selloff. President Sergio Mattarella vetoed his appointment to that role but he later took the EU affairs portfolio.
At a meeting with foreign press on Tuesday, Savona stressed he fully backed the euro and did not want to prepare for Italy to quit the single currency.
This soothed worries about the euro membership of the bloc's third largest economy under the coalition of the 5-Star Movement and the League.
"It wouldn't be a surprise for other people in the government to make these comments, but from him it's significant," said Commerzbank (DE:CBKG) strategist Christoph Rieger. "Perhaps they are recognizing that they can get more out of the EU if they at least commit to certain key principles."
The yield on Italy's two-year government bond (IT2YT=RR), the asset through which market fears about any Italian currency redenomination and debt default have largely played out, dropped well below 1 percent and was last down 5 basis points at 0.83 percent.
This is below where it started the week -- 1.13 percent -- and far from a peak two weeks ago of 2.73 percent when the market concerns were at their most intense.
Italy's 10-year government bond yield (IT10YT=RR) was 5 bps lower at 2.82 percent, while the closely-watched spread over German yields was at 235 basis points, well below the 268 bps level at the start of the week. (DE10IT10=RR)
Rieger warned that words alone would not be enough to keep Italian borrowing costs lower in the long term, particularly given the high-spending plans of the government.
"In the longer term they need to do something different to bring the deficit under control, not just pay lip service toward the euro," he said.
Other euro zone bond yields were flat to 3 basis points lower as data showed euro zone industrial production fell in April.
But investors are largely hesitating to take any strong views before two key central bank meetings. The U.S. Federal Reserve ends its policy meeting later on Wednesday while the European Central Bank meets on Thursday.
"The Fed meeting tonight is a big factor and Treasury yields could have an overriding impact on European bond markets from tomorrow," said ING strategist Martin van Vliet.
The yield on Germany's 10-year government bond (DE10YT=RR), the benchmark for the region, was down 1.5 bps at 0.48 percent though some others, such as the French equivalent (FR10YT=RR), were as much as 4 bps lower.