By Stefano Rebaudo
(Reuters) - Euro zone debt yields fell on Friday after a sharp bond selloff earlier this week but anxiety persisted about central banks' monetary tightening path and possible erratic moves in UK gilts.
Yields fell even as euro zone inflation zoomed past forecasts to hit 10.0% in September, a new record high, as expected by analysts after German data showed consumer prices increased by 10.9% over the year.
Following a surge triggered by British Prime Minister Liz Truss' controversial plan to reignite economic growth with tax cuts, British government bond markets have relatively calmed since the Bank of England announced bond purchases on Wednesday to ease market stress. Investors said they'd still wait for a credible plan to keep debt under control.
In the euro zone bond market, which has been hit by the UK-driven volatility, by 1512 GMT, Germany's 10-year government bond yield was down 9 basis points (bps) at 2.12%, considerably below the highest since December 2011 it touched at 2.35% on Wednesday.
However, it was set to end the month sharply higher, up 58 bps in September in the second-biggest monthly rise on record since 1990.
German real rates were still in positive territory, with the 10-year inflation-linked bond yield last at 0.05% .
A key market gauge of long-term inflation expectations fell to its lowest in over six weeks at 2.07%, in a sign that markets think the European Central Bank's next moves will be effective in taming the rise of consumer prices.
Graphic: EUIL5YF https://fingfx.thomsonreuters.com/gfx/mkt/znpneykjyvl/Pasted%20image%201664533172482.png
"European Central Bank officials have all the reason to continue stepping up the hawkish rhetoric," ING analysts said, referring to German and euro zone inflation data.
ECB policymakers voiced more support on Thursday for another big interest rate hike.
"Spain's (ECB policymaker Pablo Hernandez) de Cos pitched the terminal rate at 2.25-2.5% yesterday. If that is the target, then an overall increase of at least another 150 bp is on the cards over the next 'several' meetings," ING analysts added.
The ECB raised its deposit rate to 0.75% earlier in September.
Italy's 10-year government bond yield was last down 13 bps to 4.56%, with the spread between Italian and German 10-year yields at 242 bps.
Commerzbank analysts flagged that the recent jump in gilt yields triggered a widening in the Italian-German yield spread despite Italy’s election results being pretty much as expected.
"The UK experience probably played a role as market participants realise the consequences of an irresponsible economic policy," they said in a note to clients.
"The same is true for the Italian government though. The recent market developments should thus give rise to prudent announcements from the new government," they added.
Mario Draghi's outgoing government's Economic and Financial Document (DEF) will form the framework for the 2023 budget to be examined by the European Union.
(Reporting by Stefano Rebaudo, Editing by William Maclean, Emelia Sithole-Matarise and Andrea Ricci)