Euro zone yields edge higher ahead of the Fed

Jan 26 (Reuters) - Euro zone government debt yields edged up on Wednesday as investors braced for a potential hawkish surprise from the Federal Reserve but a potential bond sell-off was limited as tensions over Ukraine dampened risk sentiment.

U.S. President Joe Biden said he would consider sanctions on President Vladimir Putin if Russia invades Ukraine. Western leaders stepped up military preparations and made plans to shield Europe from a potential energy supply shock.

The recent fall in equities “serves as a warning shot for the Fed”, Commerzbank analysts said in a note to customers.

“With markets hence concerned about the impact of over-tightening of financial conditions, Powell will probably proceed with caution in order not to add fuel to the fire,” they added.

Equities rebounded on Wednesday after recent heavy losses while waiting for the Fed which will update its policy plan at 1900 GMT.

Germany’s 10-year government bond yield, the benchmark of the bloc, rose one basis point to -0.072%.

Citi analysts see “a relative lack of concern regarding the correction in equities”, but say there are still “modest hawkish risks” from the Fed.

They pointed to a potential “immediate end to asset purchases or perhaps further discussion on earlier/faster quantitative tightening (QT)” and a “faster than the quarterly pace of hikes this year”.

Italian government bond prices-- which move inversely to yields -- slightly outperformed their peers after party leaders met behind the scenes to agree on a consensus candidate for president and avoid damaging political instability.

Italy’s 10-year government bond yield fell 0.5 basis points to 1.358%.

Analysts have warned about a potential increase in Italy’s risk premium if Prime Minister Mario Draghi assumes the presidency and leave his current job.

But, should Draghi fail to be elected head of state, some commentators suggest he may not want to continue as prime minister either if the coalition backing his government splits over the presidential election. (Reporting by Stefano Rebaudo, editing by Emelia Sithole-Matarise)