* Italian yields edge higher as Banca Carige preps cash call
* Italy defiant before Tuesday deadline for revised budget
* German bond yields hit new lows on Italy, Brexit uncertainties
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates with parliament watchdog comment, price action)
By Abhinav Ramnarayan and Dhara Ranasinghe
LONDON, Nov 12 (Reuters) - Italy’s government bond yields rose on Monday as a deadline to resubmit the country’s budget to the European Commission loomed and fears grew about the future of Italian bank Carige.
News that Italy’s parliamentary budget watchdog expects the 2019 deficit to come in at 2.6 percent of economic output rather than the 2.4 percent forecast by the government also unsettled bond markets, pushing the closely-watched 10-year bond yield gap with higher-rated Germany to its widest in almost two weeks.
“We have the budget deadline tomorrow and in a market that is illiquid, one headline is enough to move prices,” said BBVA strategist Jaime Costero Denche. “We’ve also had the headlines about Carige, so this is not helpful.”
Healthy Italian banks will help to fill a 400 million euro ($451 million) hole on Banca Carige’s balance sheet, sources close to the matter said on Monday, in order to avert a possible crisis that would further destabilise the sector.
Italian bond yields were up 4-7 basis points across maturities in late Monday trade.
Two-year bond yields rose to 1.29 percent, their highest level in over a week, while the 10-year bond yield gap between Italy and Germany pushed out to 306 basis points — its widest in almost two weeks.
Data showing Italian industrial output fell by 0.2 percent in September from the month before, less than expected, after a 1.7 percent monthly jump in August helped limit the sell-off in Italian bonds.
The data was seen as an indicator of the state of the country’s economy before Tuesday’s deadline for it to submit a revised budget to the European Union.
“It’s becoming increasingly clear that whatever concession the Italian government might offer, it will fall short of the mark the Commission wants to see,” said Mizuho strategist Antoine Bouvet.
Italy has been in a showdown with Brussels over its spending plans for the coming years and last week Economy Minister Giovanni Tria said the country will stand by the main pillars of its fiscal plan despite the EU’s request to revise it.
Against this background, the demand for safe assets remained strong, while five-year credit default swaps on Italian government bonds rose to a two-week high.
German 10-year Bund yields fell to their lowest in almost two weeks at 0.38 percent.
The euro was also hurt by the uncertainty, falling to its lowest since June 2017 at $1.124, down 0.8 percent on the day.
Uncertainty over a Brexit deal between Britain and the EU also fuelled demand for safer assets, hurting sterling. (Reporting by Dhara Ranasinghe and Abhinav Ramnarayan; editing by Richard Balmforth)