CORRECTED-Fed, Italian presidential election push euro zone bond yields higher

·2 min read

(Removes last paragraph referring to Friday's Italian auction as it is on Thursday)

By Yoruk Bahceli

Jan 27 (Reuters) - Euro zone bond yields rose on Thursday as bets on a more hawkish Fed and sustained uncertainty around Italy's presidential election hurt bond markets.

The Federal Reserve said on Wednesday it is likely to hike interest rates in March and reaffirmed plans to end its bond purchases that month in what U.S. central bank chief Jerome Powell said will be a sustained battle to tame inflation.

Much was left undecided, including the pace of subsequent rate hikes or how quickly officials will run off the bank's massive balance sheet.

Powell's hawkish tone pushed U.S. Treasury yields, which move inversely with prices, higher as investors ramped up their rate hike bets to price a high probability of five rate hikes this year, compared to four before the Fed meeting.

That was also mirrored in euro zone money markets, which moved to fully price in two, 10 basis-point rate hikes from the European Central Bank by then.

Euro zone bond yields followed suit and Germany's 10-year yield, the benchmark for the bloc, was up 4 basis points by 0819 GMT to -0.03%, set for the biggest daily rise in three weeks.

Following the rout in equities, European credit markets also sold off, with the cost of insuring exposure to European investment-grade corporate bonds rising to the highest since November 2020.

The cost of insuring exposure to high yield bonds rose more sharply to the highest since early December.

But Italian bonds underperformed the market as focus remained on the country's presidential election, where lawmakers failed to elect a new head of state for a third day running on Wednesday and no consensus candidate emerging.

Former Prime Minister Matteo Renzi said he thought it would take until Friday for the centre-left and centre-right blocs to agree on a candidate.

Uncertainty around the vote, which could eventually lead to a snap election, has spurred volatility in Italian debt in recent sessions, and on Thursday the country's 10-year yield rose to the highest since June 2020 at 1.463%.

The closely watched gap with German 10-year bonds - effectively the risk premium on Italian debt - was at the highest since September 2020 at 148 bps. (Reporting by Yoruk Bahceli Editing by Mark Heinrich)