The gap between short-dated Italian and Spanish bond yields and benchmark German equivalents rose to its highest level in five months on Tuesday, even with the European Central Bank buying billions of these bonds under its asset purchase scheme.

Strategists said the poor performance was due to a weakening appetite for risky investments before the widely-expected hike from the Federal Reserve on Wednesday - a cautious approach that had roots in corporate credit markets.

"At times like this, when liquidity is very thin due to the pending FOMC decision, the correlation between asset classes has a tendency to rise significantly," said Peter Chatwell, head of European rates strategy at Mizuho.

"Thus the weakness in credit markets, which itself may also be a function of the FOMC, is apparent in euro sovereign spreads."

The U.S. high yield market has been at the epicentre of concerns that a rate rise in the world's largest economy could spell danger for companies that have borrowed mountains of debt with near zero percent interest.

Energy companies are particularly under the cosh with oil prices at the lowest levels seen since the height of the financial crisis. [O/R]

On Monday, the widely-traded iShares iBoxx $ High Yield Corporate Bond index - essentially a basket of junk debt - expanded its losses for the year to 12 percent. A competitor product, the SPDR Barclays High Yield Bond , expanded its losses for the year to 13.4 percent.

The European high yield market has also been at the sharp end of concerns in credit markets. The iTraxx Crossover -- a measure of risk that is derived from the credit default swaps of 75 sub-investment grade companies -- has risen sharply in recent days to levels not seen since early October .

Greater preference for safe haven investments has also taken its toll on investment grade corporate debt and even lower-rated sovereign debt.

Italian and Spanish two-year yields rose 1 basis point to 0.15 and 0.12 percent respectively on Tuesday, edging further away from German equivalents which were flat at -0.33 percent.

The gap between the peripheral bonds and Europe's benchmark is the widest it has been since July 10.

Nerves are likely to remain frayed until markets get the chance to digest the impact of the expected rate rise. Inflation data from the U.S. due at 1330 GMT is seen as the last piece of the jigsaw before the main event on Wednesday.

Analysts polled by Reuters expect core CPI to rise 0.2 percent in November, unchanged from the previous month.

(Editing by Andrew Heavens)

By John Geddie