By Yoruk Bahceli

(Reuters) – Italy received $12.1 billion of investor demand for its latest U.S. dollar bond sale on Tuesday, according to a lead manager, a day after its benchmark yield hit a seven-month high.

Rome, which has been diversifying its funding sources after a sharp rise in borrowing needs due to the coronavirus pandemic, is selling three- and 30-year U.S. dollar bonds via a syndicate of banks.

Analysts at Commerzbank expect the bonds will raise $5.5 billion.

It is Italy’s third venture into this market after it launched its first dollar issuance since 2010 in October 2019. That has helped it build a yield curve in U.S. dollars, with today’s sale adding to five-, 10- and 30-year bonds issued since.

Italy managed to cut the yield it is offering on both tranches, with the shorter bond receiving $6.6 billion euros of demand and the longer $5.5 billion, according to the lead manager, though the yields Italy will pay were cut by less than on past dollar deals.

“It hasn’t tightened as much from initial (price) guidance as I would have expected,” said Peter McCallum, rates strategist at Mizuho.

“Some of that might be the fact that it’s not too attractive … when swapped back into euros compared to existing BTPs,” he added.

Analysts said that for the 30-year bond, that may also reflect greater anxiety around rates volatility in the United States.

Italy also raised 5.5 billion euros in an auction of a short-term and inflation-linked bonds.

The issuance comes as Italian bond yields face upward pressure, given uncertainty over the pace of the European Central Bank’s bond buying, which holds down borrowing costs, and a budget deficit set to surge to a 20-year high.

On Tuesday, the 10-year yield rose 2 basis points to 0.82% after rising to its highest since October 2020 on Monday.

Still, positive momentum building around Italy’s recovery prospects supported the issuance. Italy unveiled a 222 billion euro economic recovery plan on Monday, after reaching a deal with the European Commission on the use of its recovery fund.

Ratings agency S&P affirmed Italy’s BBB rating – the highest among the main rating agencies – with a stable outlook last week, citing the fiscal stimulus and accelerated vaccinations.

“We’ve been adding a little bit of (additional exposure to) Italy,” said Gareth Hill, fund manager at Royal London Asset Management.

“The backdrop of having a safer pair of hands in (Prime Minister Mario) Draghi now means that we’re perhaps more comfortable from a fundamental perspective in Italy,” he said.

Broadly, there was little clear market direction ahead of the U.S. Federal Reserve meeting starting on Tuesday, with Germany’s 10-year yield, the benchmark for the euro area, unchanged at -0.25%.

(Reporting by Yoruk Bahceli; editing by John Stonestreet and Giles Elgood)