A two-notch downgrade of Italy's sovereign rating by Moody's this month means Italian linkers will drop out of the flagship Barclays inflation indexes, forcing some funds to sell their holdings at the end of the month.

Analysts at UniCredit expected Wednesday's exchange auction and the Treasury's decision not to offer linkers, but only zero-coupon paper, at an auction on Thursday to provide some relief to these bonds which are tied to euro zone's inflation.

"The exchange auction will give investors the opportunity to sell inflation-linked bonds without having to deal with the relatively low liquidity this market currently has," UniCredit said in a note.

The Treasury bought back inflation-linked bonds due in 2017, 2019, 2023 and 2035 for an overall amount of 1.326 billion euros.

The four bonds were those with a relatively high weighting in indexes and the largest outstanding amounts.

In exchange for them, the Treasury assigned 1.16 billion euros of a May 1, 2017 fixed-rate bond at a weighted average price of 94.716.

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(Reporting by Francesca Landini and Valentina Za)

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