March 7, 2017 / 9:16 AM / 5 months ago

Investors save up for Italian linker as inflation hits target

* Italy poised to sell bond linked to euro zone inflation

* Consumer price growth in bloc hit 2 percent in Feb

* German yields fall after weak economic data

* ECB to keep stimulus in place on Thursday

By John Geddie

LONDON, March 7 (Reuters) - Investors sold fixed-rate Italian government bonds on Tuesday in order to free up room in their portfolios for new inflation-linked debt that will offer protection against rising consumer prices in the euro zone.

The Italian government took the market by surprise late on Monday by announcing it had hired a group of banks to manage the sale of a 10-year bond which has its interest linked to euro zone inflation, according to market news and data service IFR.

The sale, to be priced later on Tuesday, comes after data showed inflation in the 19-member bloc rose to 2 percent for the first time in four years last month, roughly in line with the European Central Bank's medium-term target.

The yield on the equivalent Italian fixed-rate bond rose 2 basis points on Tuesday to 2.17 percent, its highest in around 10 days. In neighbouring Spain, yields rose as much as 3 bps to a two-week high of 1.73 percent.

Bond yields move inversely to prices.

"The main reason for the move is supply," said Luca Cazzulani, a strategist for UniCredit in Milan.

"The timing is pretty smart because it comes right after the print of the preliminary inflation figure that just touched 2 percent so I think the deal will go well. The money is there and it comes close to this data that will foster demand for inflation protection."

Italy's bond adds to a scheduled auction from Austria of debt maturing in 2026 and 2034, and a 10-year bond sale from euro zone bailout fund ESM which has already attracted more than 4 billion euros of demand, IFR reported.

Aside from the supply-related moves, some lacklustre economic data dragged down yields slightly in the bloc's core debt markets. Weak economic data supports the ultra-easy monetary policy of the ECB which has kept yields in check.

A sharp fall in domestic and euro zone demand drove the biggest monthly slump in German industrial orders in eight years in January, data showed.

The ECB meets on Thursday and is expected to resist calls from certain quarters to rein in its stimulus programme.

German 10-year bond yields fell 1 basis point to 0.34 percent, while yields on most other highly-rated equivalents also nudged lower.

The gap between German 10- and two-year yields held at 118 basis points, within sight of its widest level since July 2014.

The bulk of that move has been driven by frenetic demand for two-year German bonds, seen as one of the safest assets in the euro zone but in short supply due to central bank purchases. Nervousness around France's upcoming election has also left investors looking for safe places to park cash.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

editing by John Stonestreet

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