Italian bonds rallied, sending the 10-year yield below 3pc for the first time since May, as investors bet that a new government won't put at risk the reforms needed to unlock funds for the country from the European Union.
Yields fell as much as 16 basis points to 2.86pc, tightening the spread over equivalent German securities for a third day -- the longest streak since June -- to 209 basis points.
It comes after Bloomberg News reported on Friday that far-right leader Giorgia Meloni, who is leading in opinion polls ahead of snap elections in September, plans to adhere to EU budget rules.
The nation stands to receive around €200bn of EU funds.
The rally more than erases the widening in spreads that followed Mario Draghi's resignation as prime minister, a move that has raised the prospect of political instability and stoked fears that an administration less committed to modernizing the economy could come to power.
It also takes pressure off the European Central Bank, which has pledged to step in if Italy's borrowing costs start rising too much relative to Germany's.
"It reflects hopes that the election campaign and the new government will not challenge Draghi's fiscal and reform record," said Antoine Bouvet, senior rates strategist at ING Groep NV, adding "it is of course early days and I would personally be cautious before reaching any conclusion on that front."
The premium investors demand to hold Italian bonds over German equivalents widened to almost 250 basis points after Draghi's government collapsed last month, a level that some investors say could prompt policy makers into action.
The selloff was compounded as the ECB kicked off its first tightening cycle in a decade, a major headwind for weaker economies such as Italy's.
An indicator for economic activity in Italy by S&P Global fell for a fifth consecutive month in July to the lowest since June 2020, highlighting the challenges the nation faces.
The FTSE MIB index outperformed other European equity benchmarks on Monday, rising 0.9pc and led by insurance stocks.