Belgian bonds on Tuesday weathered an unexpected rating downgrade, highlighting a divergence between how the market and some credit agencies view the country's debt profile. Italian bonds lagged, however, with the 10-year yield rising 4 bps to 1.85 percent by 1500 GMT, after three sources close to the matter told Reuters the government in Rome was likely to have to put in around 6.5 billion euros ($6.79 billion) to rescue troubled bank Monte dei Paschi di Siena.

An auction scheduled for Thursday also put pressure on Italian bonds. Fitch cut Belgium's rating by one notch to AA- on Friday evening, citing its relatively high debt and upward revisions to fiscal deficit targets.

DZ Bank strategist Daniel Lenz said he was "not at all convinced" by the notion of cutting Belgium by one notch while keeping France unchanged "even though (it) faces similar pressures". Fitch earlier this month maintained France's rating at AA with a stable outlook.

Lenz cited Belgium's "better unemployment figures, better current account deficit and upcoming elections in France" as all reasons why he believes Belgium should be rated at least on a par with France. Belgium's debt to GDP ratio is however higher at 105.8 percent compared to France's 96.20 percent, as of 2015, according to Reuters data. With Fitch's downgrade, France is rated a notch higher than Belgium by three of the four main credit agencies.

However, Belgium's borrowing costs remain lower than those of its neighbour. At 1500 GMT on Tuesday the yield on Belgium's 10-year government bond fell 3 basis points to 0.53 percent, 14 basis points below the French equivalent, which also fell 3 bps to 0.67 percent. Most higher-rated government bond yields fell 2-3 bps on the day, with the yield on two-year German government bonds, or "Schatz", dropping 2 bps to a record low of 0.82 percent.

Schatz have rallied strongly in recent months with investors struggling with a shortage of short-dated bonds that are used as collateral to borrow in money markets. The effect has intensified since the European Central Bank made tweaks to its bond-buying scheme that are likely to focus purchases on the short end of the government bond market. Two-year Greek government bond yields - which are not eligible for ECB purchases - traded at 7.86 percent, close to recent highs, as investors reacted cautiously to comments from Eurogroup chief Jeroen Dijsselbloem that talks about initial debt relief measures for Athens would resume.

Debt relief was frozen mid-month over Greece's decision to pay pensioners a Christmas bonus. "I think overall this is positive news for the Greek government, and it will be eventually reflected in markets. Trading is thin at the moment so it is hard to read too much into it," said Lenz.

Copyright Reuters, 2016