LONDON, Aug 11 (Reuters) - German government bond yields rallied to a two-week high on Thursday, as U.S. Federal Reserve officials downplayed Wednesday's softer-than-expected consumer inflation figures and affirmed their commitment to tighter policy.
Germany's 10-year bund yield soared as much as 10 basis points (bps) and was last up 8 bps at 0.969%, recouping losses sustained on Wednesday and having been down 1 basis points earlier in the afternoon.
U.S. PPI figures came in below expectations on Thursday, echoing soft consumer inflation data published on Wednesday.
"The Fed is the big player, and when rate expectations move higher or lower, you see it happen, to a lesser extent, in Europe," said Shane O’Neill, head of interest rates at Validus Risk Management.
"The job isn't done and the Fed have reiterated that they are still going to be fighting inflation."
Money markets are pricing in an almost 65% chance of a 50 bp hike from the Fed at next month's meeting and around a 37% chance of a 75 bp hike. Traders are pricing around 115 bps of tightening by year end, according to Refinitiv data.
Expectations for aggressive rate hikes from the Fed have also boosted bets for a large rise from the European Central Bank (ECB) in September.
Traders fully price in a 50 bp rate rise next month and around 116 bps of rate rises this year, Refinitiv data showed.
Italian 10-year yields were up about 3 bp to 3.024%.
Italy's 2-year yield outperformed, and was last up 1 bps to 1.284%.
The closely-watched 10-year yield gap between Italy and Germany tightened to 205 bps, down from around 213 bps on Monday after ratings agency Moody's cut Italy's outlook to "negative" from "stable".
The leader of the Brothers of Italy party, Giorgia Meloni, who is ahead in the polls to become the next prime minister, released a video on Wednesday saying a right-wing government led by her would not threaten financial stability. Italy heads to the polls on Sept. 25.
(Reporting by Samuel Indyk and Lucy Raitano; Editing by Andrew Heavens and David Holmes)
