May 2, 2018 / 11:56 AM / 3 months ago

UPDATE 2-Italian bonds outperform as president allays snap election fears

* Italy/Germany spread tightens as president rules out June vote

* Euro zone yields rise as strong GDP growth confirmed

* U.S. Federal Reserve concludes 2-day meeting

* Euro zone bond yields rise

* Euro zone periphery yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Fanny Potkin and Dhara Ranasinghe

LONDON, May 2 (Reuters) - Italian government debt was in demand on Wednesday after Italy’s president soothed concerns about a possible snap election in June which investors fear might raise the chances of a high-spending populist coalition.

Italian 10-year bond yields fell 2.5 basis points (bps) to 1.754 percent at one stage, before all euro zone yields were pushed higher by a sell-off in U.S. Treasuries and data suggesting the euro zone economy was not as weak as expected.

The Italian yield spread over equivalent German Bunds tightened as much as 5 bps at one point and closed the day at 120 bps.

The news also pushed Italy’s blue-chip FTSE MIB index up a hefty 1.2 percent.

However, trading volumes remained subdued after most European markets were closed on Tuesday for the May Day holiday.

On Italy, Sanlam Strategic Bond Fund fund manager Craig Veysey said the situation remained unpredictable and it was important not to over-interpret the political noise.

“We are still in a stalemate situation in Italy. It’s still up in the air whether or not there will be a push for fresh elections come the summer,” he said.

Italian politics have been in limbo since an inconclusive March 4 vote, which saw a centre-right alliance led by the anti-immigrant League win the most seats and the anti-establishment 5-Star Movement emerge as the biggest single party.

The 5-Star leader has called for new elections next month.

On Wednesday, a presidential palace source told Reuters President Sergio Mattarella wants a new government in place to pass the 2019 budget.

Elsewhere, most better-rated euro zone bond yields rose 2-3 bps on the day. An overnight rise in U.S. Treasury yields weighed on sentiment as did euro zone economic growth data that was stronger than some economists expected.

Germany’s 10-year Bund yield, the benchmark for the bloc, rose to 0.58 percent, but held below six-week highs set last week above 0.65 percent.

Gross domestic product across the euro zone expanded by 0.4 percent in the first quarter compared to the last quarter of 2017 and by 2.5 percent year on year, EU statistics agency Eurostat said on Wednesday.

A softening in the euro zone’s strong growth momentum and still-subdued inflation have prompted investors to push back their European Central Bank rate-hike expectations.

In contrast, the U.S. Federal Reserve is in the middle of a rate-hiking cycle although no changes to monetary policy are expected when the bank concludes a two-day meeting on Wednesday.

“Euro zone markets are in wait-and-see mode until the Fed meeting,” ING rates strategist Martin van Vliet said.

U.S. Treasury yields fell on Wednesday as a quarterly refunding program that aims to finance the country’s massive fiscal deficit came in short of expectations, reducing the pressure on prices caused by the increase in debt supply.

Reporting by Dhara Ranasinghe and Fanny Potkin Additional reporting by Danilo Masoni Editing by Louise Ireland and Hugh Lawson

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