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German bond yields edge higher as Fed officials downplay softer CPI

LONDON, Aug 11 (Reuters) - After falling on Wednesday, German government bond yields crept higher on Thursday, echoing moves in U.S. Treasuries, as Federal Reserve officials downplayed the softer-than-expected inflation figures and affirmed their commitment to tighter policy.

On Wednesday, a report showed U.S. consumer prices were unchanged in July due to a sharp drop in the cost of gasoline. Economists polled by Reuters had forecast a 0.2% rise in the monthly CPI.

U.S. Treasury yields plunged after the data but reversed course as Fed officials said further interest rate hikes were needed and it was too early to declare victory on inflation.

German government bond yields followed moves in their U.S. counterparts.

The 10-year bund yield was last up 2 basis points (bps) at 0.907%. It initially fell 8 bps after the data before recouping some of the fall.

"We had three regional Fed Presidents hitting the mic, and the message was that they want to continue to tighten with rate hikes next year," Arne Petimezas, senior analyst at AFS Insights, said.

"For them, the CPI report doesn't change anything."

Money markets are pricing in around a 65% chance of a 50-basis-point hike from the Fed at next month's meeting and around 115 basis points of tightening by year end, according to Refinitiv data.

Expectations for aggressive rate hikes from the Fed also boosted bets for a large rise from the European Central Bank in September.

Traders fully price in a 50-bps rate rise next month and around 116 bps of rate rises this year, Refinitiv data showed.

Italian bonds outperformed their euro zone peers with 10-year yields down 2.5 basis points to 2.96%.

Italy's 2-year yield fell 5.5 bps to 1.245%.

The closely-watched 10-year yield gap between Italy and Germany tightened to almost 205 bps, down from around 213 bps on Monday after ratings agency Moody's cut Italy's outlook to "negative" from "stable".

"We had pointed out on Monday that the ratings-induced pressure won't last long," Commerzbank rates strategist Hauke Siemßen said in a morning note.

"Given the mix of ECB support combined with easing political fears and carry considerations, we maintain our constructive BTP view."

The leader of the Brothers of Italy party, Giorgia Meloni, who is leading in the polls to become next prime minister, released a video on Wednesday saying that a right-wing government led by her would not threaten financial stability. Italy heads to the polls on Sept. 25. (Reporting by Samuel Indyk; Editing by Andrew Heavens)

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