(Bloomberg) -- Italy’s bonds are underperforming peers as European Central Bank policy makers signal their pace of selling debt could pick up next year.

The nation’s 10-year bond yield climbed as much as six basis points on Tuesday, compared to a one basis-point increase on equivalent German notes, after Bundesbank President Joachim Nagel said the central bank’s balance sheet must shrink significantly.

Italy’s bonds are particularly affected by the ECB’s so-called quantitative tightening because they were the main beneficiaries of its debt-buying programs in recent years. Analysts and investors say there’s a risk the central bank will taper reinvestments of its €1.7 trillion ($1.9 trillion) pandemic bond portfolio, known as PEPP, earlier than anticipated, which would flood the market with more Italian debt.

The central bank may be more willing to do so following a rally in Italian debt in the past month that’s cut its risk premium over Germany, said Theophile Legrand, strategist at Natixis SA. Moody’s Investors Service decision to rule out a downgrade in the short term has also boosted the prospect, he said.

“The ECB could be more comfortable on the QT,” Legrand said. “We see risks that an announcement could be made in January 2024 for a start in April,” he said, adding PEPP reinvestments could stop in July.

The market is taking notice of Nagel’s comments given they come just a day after ECB President Christine Lagarde said that officials may soon revisit PEPP and reconsider how long they will replace maturing securities. Under current guidance, reinvestments are set to continue in full until the end of next year.

While several officials have said they’re in favor of discussing an earlier start to the roll-off of the so-called PEPP program, Lagarde had previously remained more cautious on the issue. After the last policy meeting in October, she only said the issue hadn’t been discussed.

“It is clear to me that the large balance sheet will have to shrink further significantly,” Nagel said on Tuesday. He added it’s premature to even talk about interest-rate cuts. 

Althea Spinozzi, a strategist at Saxo Bank A/S, said markets are being complacent to expect the ECB’s next move to be rate cuts. Swaps tied to the central bank’s meeting dates imply 92 basis points of easing next year. 

“If the ECB cannot initiate this conversation now that markets are complacent, and send the message that PEPP needs to be unwound now, it will never be able to disinvest PEPP,” she said. 

Spinozzi expects Italy’s yield premium over Germany to climb above 200 basis points next year, from 178 basis points currently. 

--With assistance from Alice Gledhill.

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