* Italian/German bond yield gap off over 4-month highs
* Italy yields set for biggest weekly jump in over a year
* UST yields pull back from highs
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Dhara Ranasinghe
LONDON, May 18 (Reuters) - Italian government bond yields were set on Friday for their biggest weekly jump in over a year, with unease over the plans of a coalition government taking shape in Rome keeping upward pressure on borrowing costs.
The common government policy agenda of Italy’s two anti-establishment parties includes the issuance of short-term government bonds to pay companies owed money by the state, the economics chief of far-right League, Claudio Borghi, said early on Friday.
Asked if so-called “mini-BOTs” - named after Italy’s short-term Treasury bills - would be in the agenda, Borghi said “yes”.
This prospect of increased issuance helped explain renewed weakness in Italian bonds, analysts said.
While most bond yields in the euro zone dipped in early trade, as U.S. Treasury yields pulled back from multi-year highs , Italy continued its underperformance.
Italy’s 10-year bond yield was up 3 basis points at 2.14 percent and near Thursday’s 3-month highs. It is up 26 bps this week, the biggest weekly rise since March 2017.
“I suspect that the mini-BOT news is pushing prices a bit lower,” said DZ Bank strategist Andy Cossor.
The gap between Italian and German 10-year bond yields - a closely watched indicator of relative risks - was at 151 basis points, having touched its widest levels since early January on Thursday at around 157 bps .
A draft programme for a potential coalition government between the anti-establishment 5-Star Movement and far-right League earlier this week revealed plans to demand 250 billion euros of debt forgiveness and create procedures to allow countries to exit the euro, jolting markets.
A 5-Star source said on Thursday the programme contained no reference to a possible exit from the euro or “anything that could cause any concern regarding Italy’s euro membership”.
Still, the headlines this week have prompted investors to pay closer attention to Italian political risks.
On Thursday, the two parties agreed the basis for a governing accord that would slash taxes, ramp up welfare spending and pose the biggest challenge to the European Union since Britain voted to leave the bloc two years ago.
While the Italian/German bond yield spread has widened it remains below peaks seen early last year when investors fretted about euro zone break up risks ahead of the French presidential election.
“The more we think about it, and the more we speak to major investors in BTPs, the more we conclude that the violent spread widening earlier in the week was simply caused by a flush out of risk-averse periphery investors,” said Peter Chatwell, head of rates strategy at Mizuho.
Reporting by Dhara Ranasinghe Editing by Alison Williams