EURO GOVT-Italian yields rise as market mourns Monti exit
* Italian bonds pressured by political upheaval, yields rise
* Italy to remain volatile, supply pressure adds upward bias
* Bunds in limbo awaiting confirmation of more Fed asset buying
By William James
LONDON, Dec 11 (Reuters) - Italian yields crept higher on Tuesday, adding to a selloff seen in the previous session triggered by technocrat Prime Minister Mario Monti's decision to resign early, which has shaken faith in Italy's reform agenda.
Monti will resign once the 2013 budget has been passed, bringing forward an election and causing some to sell their bonds, anticipating a drawn-out political tussle that could undermine Italy's commitment to austerity.
"This came really as a blow to the market. Everyone was prepared to head into year-end with a benign environment of low yields and volatility and good liquidity," said Michael Leister, senior strategist at Commerzbank in London.
The return to frontline politics of former Prime Minister Silvio Berlusconi, anathema to many investors, also knocked confidence. On Tuesday, Berlusconi accused Monti of pursuing German-centric policies -- comments that point to a bitter election campaign fought over European issue.
Italian 10-year bond yields were 4.6 basis points up on the day at 4.86 percent, having risen by 27 basis points in the previous session. The Spanish equivalent, which suffered along with Italy on Monday, was steady at 5.58 percent.
Market participants were expecting increased volatility over the coming months and even though some saw any selloff as a chance to redouble longer-term bets on lower yields, a return to the two-year lows seen last week was unlikely.
"In Italy for now we have seen the lows in yields this year and with supply looming on Thursday we believe there is further upside pressure on the cards," Leister said.
Italy will sell new three-year debt alongside an existing 2026 bond at an auction on Thursday, planning to raise up to 4.25 billion euros.
German Bund futures were 10 ticks higher at 145.70 with traders not expecting significant price swings or trading activity before the outcome of the U.S. Federal Reserve's two-day policy meeting starting later in the session.
A Reuters poll showed the Fed is expected to announce that it will extend its asset purchase scheme and commit to buy $45 billion of U.S. debt per month, helping to keep yields low on closely-correlated German Bunds.
"The market will be severely disappointed if we don't get fresh purchases now. You'd feel that outcome is in the price, there's now more risk that they don't do anything and we get disappointment," a trader said.
"Bunds will be sensitive to that, particularly given the rally we've had back to the low end of the yield range."
German 10-year yields were 0.9 bps lower on the day at 1.291 percent, toward the lower end of the range defined during the second half of the year by July's low of 1.126 percent and September's high of 1.702 percent.
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