* Italian yields dip 1-2 bps ahead of sale of 5 and 10-yr bonds
* German yields rise with inflation expected at 7-yr high for Oct
* Italian lawmakers due to vote on draft budget this week
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Abhinav Ramnarayan
LONDON, Oct 30 (Reuters) - Italian government bonds yields dipped for a second day in a row on Tuesday towards one-month lows before a key auction of bonds, while Germany was expected to announce its highest inflation figure in seven years.
Buoyed by S&P Global’s decision not to downgrade Italy’s credit rating on Friday, the country’s borrowing costs dipped another 1-3 basis points across the curve.
The move is particularly striking as it comes before an up to 4.5 billion euro auction of five-year and 10-year bonds - normally, yields rise before an auction as investors make room for the new supply.
“I think after this move we can expect a positive outcome in the auction - Italy has already managed to get auctions through in much worse scenarios this year,” DZ Bank rates strategist Daniel Lenz said.
With the day’s rally, Italy’s 10-year bond yield is now at 3.32 percent, 10 basis points below Friday’s close and the closely-watched spread over Germany is at 293 basis points, close to its tightest level in three weeks.
The five-year Italian yield was 2.5 bps lower at 2.57 percent, close to a one-month low.
However, analysts warned of potential volatility later this week, with Italian lawmakers expected to vote on a contentious budget draft that has put the country at odds with Brussels.
“It looks like there will be no changes to the first draft, no sign of a compromise, so this could be bad news for the market,” said Lenz of DZ Bank.
Other euro zone bond yields edged higher before the release of German inflation data for the month of September, which is expected to be at 2.3 percent, according to a Reuters poll. DZ Bank reckons this would make it the biggest rise in consumer prices in the bloc’s largest economy in seven years.
Long term euro zone inflation expectations this week dipped to its lowest in a year at 1.659 percent, according to a key market gauge, the five-year five-year forward inflation swap , but this data could give inflation bets a boost.
It could also mean that the ECB is moving towards its targeted inflation of just below 2 percent for the euro zone, which could put upward pressure on bond yields.
German 10-year government bond yields, the benchmark for the bloc, were 1.5 bps higher at 0.395 percent.
They had already risen three bps on Monday - moving away from seven-week lows - after German Chancellor Angela Merkel said that her fourth term as chancellor would be her last and that she would step down as leader of the Christian Democrats.
The German state of Saxony recorded above-expectations inflation of 2.5 percent for the month of October on Tuesday.
Other German state inflation data will filter through ahead of the countrywide figure, which will be released at 1300 GMT. (Reporting by Abhinav Ramnarayan)