Euro zone yields fell on Tuesday, with Italian bond prices outperforming their peers, after European Central Bank officials reiterated that any monetary policy change will be gradual.

ECB president Christine Lagarde said on Monday there was no need for extensive tightening as inflation is set to fall back and could stabilize around 2%.

ECB member Pablo Hernandez de Cos on Tuesday said any central bank move "has to be gradual".

Euro zone borrowing costs jumped to multi-year highs in recent days as investors ramped up their bets on higher interest rates this year after last week's ECB hawkish shift.

Money markets are pricing an around 90% chance of a 10 bps rate hike in June and an almost 100% chance of a 50 bps rate hike by December.

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Germany's 10-year government bond yield, the benchmark of the bloc, fell 1.5 bps to 0.206%, within striking distance of its highest since January 2019 around 0.25% it hit on Monday and reached again earlier in the session.

Italian government bonds outperformed their peers after heavily underperforming recently, with the 10-year yield falling 3.5 bps to 1.773%.

The spread between Italian and German 10-year yields tightened to 156 bps.

Citi analysts said that while the Italian-German yield spread "turned around following Lagarde's speech and might briefly respond further to any dovish comments, the market will likely remain wary of a faster Asset Purchase Programme (APP) taper into the March meeting."

Peripheral debt came under selling pressure as investors shifted their focus to bond supply amid concerns that the phasing out of the ECB's bond purchase programme might reduce demand for bonds of the most indebted countries, boosting their risk premium.

"It remains to be seen whether (Lagarde) reiterating the flexibility 'under stressed conditions' would be enough" to support peripheral yields, Commerzbank analysts said.

PEPP ends in March, but analysts expect the ECB to boost its Asset Purchase Programme (APP) beyond 20 billion a month to implement a gradual monetary tightening.


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