UPDATE 2-Fed pushes euro zone bond yields higher

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By Yoruk Bahceli

Jan 27 (Reuters) - Euro zone bond yields rose on Thursday as bets grew on a more hawkish U.S. Federal Reserve, while Italian bonds outperformed as the country's main political blocs showed willingness to solve the impasse in the ongoing presidential election.

The Fed said on Wednesday it is likely to hike interest rates in March and reaffirmed plans to end its bond purchases that month in what the central bank's chief Jerome Powell said would be a sustained battle to tame inflation.

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

Powell's hawkish tone pushed short and medium-dated Treasury yields higher as investors priced in nearly a full probability of five rate hikes this year, compared to four before the Fed meeting.

Euro zone bond yields rose on the news and Germany's 10-year yield, the benchmark for the bloc, was up 1.4 basis points at 1623 GMT to -0.058% after rising as much as 4 bps in earlier trading.

A market gauge of long-term euro zone inflation expectations fell close to its lowest since late November at 1.8247% as bets on monetary policy tightening continue to cut inflation expectations.

Elsewhere, Italian bonds outperformed with the 10-year yield dropping about 4 basis points to 1.36% after reaching the highest since June 2020 at 1.463% in earlier trade.

Italy's parliament has failed for four days running to pick a new head of state but hopes grew that the stalemate will soon end, encouraging investors to buy back into the country's debt.

Italian League leader Matteo Salvini said he hoped a new president would be elected on Friday and told reporters that he would shortly propose non-partisan candidates to the centre-left bloc.

Earlier, former prime minister Matteo Renzi also predicted a deal would be reached by Friday.

Uncertainty around the vote, which has thrown into doubt whether former ECB president Mario Draghi's government will endure, has spurred volatility in Italian debt and pushed the risk premium over German bonds to the highest since September 2020.

Lyn Graham-Taylor, senior rates strategist at Rabobank, cautioned against reading too much into political headlines and added that Italian bonds might also be strengthening as part of a broader rally in risk assets, with U.S. stocks extending gains in afternoon trading.

The risk premium with Germany, after rising to a its highest since September 2020 at over 150 bps in earlier trade, was last down to 140.9 bps. (Reporting by Yoruk Bahceli; Additional reporting by Julien Ponthus; Editing by Mark Heinrich, Bernadette Baum and Barbara Lewis)

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