Gap between Italian and German bond yields hits 7-month low

LONDON, Jan 22 (Reuters) - The spread between Italian and German 10-year borrowing costs hit a seven-month low on Monday as yields fell slightly after rising sharply the previous week.

The gap, which is seen as a gauge of investor sentiment towards Italy and the euro zone's more indebted countries, fell below 154 basis points (bps) in early trading and was last at 156 bps, unchanged from Friday's finish.

Germany's 10-year bond yield, the benchmark for the euro zone, fell 2 bps to 2.283% after rising 16 bps the previous week. Yields move inversely to prices.

Investors were looking towards the European Central Bank's interest rate decision on Thursday. The ECB is all but certain to leave interest rates on hold at 4% but investors will be listening closely to President Christine Lagarde for signals about when interest rates are likely to start falling.

A chorus of ECB policymakers last week pushed back on traders' expectations for quick and deep rate cuts this year. Some analysts said a consensus appeared to be building among ECB officials that rates were unlikely to fall until the summer.

Italy's 10-year bond yield, was last down 2 bps at 3.85% after rising 15 bps last week.

The closely watched Italian-German spread has narrowed from a 10-month high above 200 bps in October as markets have begun to expect rate cuts from the ECB.

"In Europe, what we like still is very much the periphery, particularly Spain and Italy," said Andres Sanchez Balcazar, head of global bonds at Pictet Asset Management.

"Those curves give you a bit more yield than the German curve and if the ECB is compelled to ease, then the pressure on many of those peripherals is going to ease as well."

Germany's 2-year bond yield, which is sensitive to interest rate expectations, was down 2 bps at 2.709% after rising 21 bps last week.

Markets on Monday were pricing in around 130 bps of rate cuts from the ECB this year, up slightly on Friday but down from the almost 170 bps priced in a the start of the year.

"Current market pricing makes much more sense to us," Mohit Kumar, chief economist and strategist for Europe at Jefferies, said in a note to clients on Monday. "We do not see much scope for a further back up in rates." (Reporting by Harry Robertson; Editing by Alex Richardson)