* Italian yields soar after Italian parliament dissolved
* Analyst warns of further volatility as election day approaches
* German yields also at two-month high before inflation data (Updates prices, adds German data)
By Abhinav Ramnarayan
LONDON, Dec 29 (Reuters) - Italian government bond yields climbed to two-months highs on Friday, a day after the president dissolved parliament and a general election was scheduled for March 4.
The vote is expected to produce a hung parliament, which could result in instability and possible market turbulence for the euro zone’s third largest economy.
“Even though the risk of an anti-EU government is not as big as 12 months ago, spreads could still widen further as the election day comes closer,” said ING strategist Martin van Vliet.
“Don’t forget also the long-term outlook for Italy remains challenging, with high indebtedness and low structural growth. The question for investors is what will happen in the next downturn,” he said.
The yield on Italy’s 10-year government bond rose to 2 percent for the first time since late October, up 6 basis points on the day, before settling at 1.99 pct.
The yield spread over benchmark German Bunds was also at about its widest since late October at 153 bps.
Just three weeks ago, Italian borrowing costs had fallen to their lowest in over a year at 1.63 percent, in a rally caused by the European Central Bank’s decision to continue its bond-buying progamme until at least September 2018.
But now, Van Vliet said ING’s forecast that the Italian-German yield spread will reach 175 to 200 bps before the election looks more likely.
“At the start of December everyone was like, really? But now it looks highly possible,” he said.
German 10-year borrowing costs hit a two-month high of 0.445 percent on Friday after data showed the country’s inflation reached a five-year high in 2017. Consumer prices rose by 1.6 percent year-on-year in December for Germany, initial data showed on Friday. That is likely to create more discord at the European Central Bank, where some policymakers want to stop pouring money into the euro zone .
Euro zone economic growth has accelerated in 2017, but the inflation hasn’t kept pace, particularly when the effect of higher oil prices is stripped out.
“The dip in core inflation is set to be followed by lower headline inflation today and next month. Whether the market looks through these falls is debatable,” Mizuho strategist Peter Chatwell said in a note.
Reporting by Abhinav Ramnarayan & fanny Potkin, editing by Larry King