* Italian bonds rise then fall back after report Di Maio to quit
* Fresh elections unlikely just yet – analysts
* Other bond markets quiet as risk appetite picks up (Updates with latest prices)
By Saikat Chatterjee and Dhara Ranasinghe
LONDON, Jan 22 (Reuters) – Italy’s bond yields were back at levels at which they started the day on Wednesday despite reports that Luigi Di Maio will step down as the 5-Star movement’s leader, because the imminent collapse of the ruling coalition was seen as unlikely.
Di Maio will step down as leader of Italy’s co-governing 5-Star movement on Wednesday, a senior party source said. He is also Italy’s foreign minister.
While his resignation is not expected to bring down the government, it would underscore deep divisions within 5-Star. The populist party, the largest in the ruling coalition, has been hit by rising defections and plummeting poll ratings.
Italian government bond yields jumped as much as 8 basis points, as prices tumbled, but later pulled back.
The benchmark 10-year Italian bond yield traded around 1.37% , reversing all of its earlier rise.
The closely watched spread between 10-year yields on Italian bonds and comparable German debt had hit its widest since late December at 169 bps before narrowing.
“The initial reaction was to sell because of the heightened political uncertainty but there is no outright link between Di Maio’s resignation and a collapse of the government,” said Luca Cazzulani, a rates strategist at UniCredit in Milan.
Others saw no major incentive for any of the parties in the coalition government to call an election.
Still, an election in Italy’s Emilia Romagna region this weekend was in focus as the latest gauge of support for Italy’s leading political parties.
Goldman Sachs analysts point out that the region has been a traditional centre-left stronghold, so a loss by the centre-left could raise concerns over the national government’s stability.
In a sign of unease at political developments, the cost of insuring Italian government bonds against the risk of a default rose and Italian banking stocks hit a six-week low.
Analysts noted the brief selloff in Italian bonds was also used as opportunity to move back into the higher-yielding debt market given the fact that much of the European bond market is in negative yield territory.
“BTPs widened at the open but we’ve seen real money investors buying at those levels,” said Carlo Franchini, head of institutional clients at Banca Ifigest in Milan. “Italian bonds are the only ones with a positive yield and this compensates for political volatility.”
Investors were also wary of changing bond positions aggressively before Thursday’s European Central Bank meeting.
The ECB’s first meeting of the year is set to bring the formal launch of a strategy review, most likely including a rethink of an inflation goal the bank has failed to meet since 2013.
Elsewhere, most other 10-year bond yields were steady on the day. Germany’s 10-year Bund yield was flat at around -0.25% .
(Reporting by Saikat Chatterjee and Dhara Ranasinghe; Additional reporting by Danilo Masoni in MILAN and Tommy Reggiori Wilkes; Editing by Simon Cameron-Moore and Timothy Heritage)