May 8, 2018 / 8:01 AM / in 3 months

South European bonds lag on Italian politics, strong German data

* South Europe yields higher 4-5 bps on Italy election worries

* Strong German data also pushed euro zone yields higher

* Optimism in markets despite impending U.S. decision on Iran deal

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, May 8 (Reuters) - Investors shed Southern European government bonds in general and Italian debt in particular on Tuesday as the bloc’s third-largest economy struggles to form a government after an inconclusive general election in March.

President Sergio Mattarella called on Monday for Italy’s bickering parties to rally behind a “neutral government”, but Italy’s two largest parties, the far-right League and anti-establishment 5-Star Movement, rapidly came out against the proposal.

This raises the likelihood of an unprecedented immediate return to the polls, even as early as July.

The closely watched Italy/Germany 10-year government bond yield spread hit its widest level in three weeks at 128 basis points, while Italian 10-year yields were at their highest in two weeks.

Other Southern European government bond yields — which move inversely to price — were also higher 3-4 bps.

Yields were also higher across the board as strong German data soothed concerns over the euro zone’s largest economy and increased expectations the ECB will withdraw stimulus as planned.

German industrial output rose more than expected in March, data showed on Tuesday, suggesting that factories in Europe’s largest economy ended the first quarter on a strong footing after two disappointing months.

Separate data published by the Federal Statistics Office showed exports rose 1.7 percent in March while imports fell 0.9 percent.

“After weak German industrial orders yesterday, today’s numbers look much better and point towards decent GDP growth in Germany,” said Commerzbank strategist Christoph Rieger, adding that this should lead to lower Bund futures and therefore higher yields.

The yield on Germany’s 10-year government bond, the benchmark for the region, was higher by one basis point at 0.54 percent.

These yields have been kept low in recent times by weak inflation readings, but the European Central Bank’s chief economist Peter Praet played this down this week, saying a drop in “core inflation” may be a one-off.

A broad optimism across global markets may also explain the move higher in yields.

World markets were mostly in upbeat mood on Tuesday, with oil prices holding above the $75 a barrel level despite an expected U.S. government decision on its involvement in the international Iran nuclear deal.

The euro fell below $1.19 for the first time this year on Monday, but has since recaptured that level.

Meanwhile, the U.S. Federal Reserve Chairman Jerome Powell said on Tuesday the Fed’s interest rate hikes may not pose as big a risk for global financial markets and emerging market economies as many have thought.

Reporting by Abhinav Ramnarayan, editing by Louise Heavens

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