An illustration picture shows euro coins, April 8, 2017. REUTERS/Kai Pfaffenbach

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LONDON, Sept 5 (Reuters) – Italian government bond yields led a rise in borrowing costs across the single currency bloc on Monday after Russia’s decision to keep its main gas pipeline to Germany shut exacerbated inflation and ECB rate-hike fears.

Russia’s latest halt to gas supplies down its main pipeline to Europe, which came after Friday’s bond market close, comes just days before the European Central Bank is expected to deliver a second big rate hike to tame record-high inflation. read more

The European benchmark gas contract soared 30% at the open, while the euro sank to a 20-year low below 99 cents – adding to price pressures since a weak currency lifts the cost of imports.

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Against this backdrop, Italian 10-year bond yields headed back towards 4% and German Bund yields also rose, having dipped in early trade.

“The primary focus is the inflationary impact with the ECB increasingly focused on realised inflation rather than relying on its forecast,” said ING senior rates strategist Antoine Bouvet, referring to the gas pipeline shutdown.

“This means higher bond yields and a curve flattening. Even if measures mulled by Germany and the European Union are going to ease the blow for energy consumers, I expect markets to read this as hawkish, as it would clear the way for more ECB hikes.”

Italy’s 10-year bond yield was last up 10 basis points (bps) at 3.94% , approaching more than two-month highs hit last week above 4%.

Germany’s benchmark 10-year Bund yield was 2 bps higher at 1.54%, having fallen at the open.

Euro area money markets meanwhile were pricing in roughly 88% chance of a 75 bps ECB rate hike on Thursday when the central bank meets, up from roughly 80% at the end of last week.

The euro was down 0.5%, having hit a new two-decade low and European stock markets were deep in the red (.STOXX).

Germany will spend at least 65 billion euros ($64.7 billion) on shielding customers and businesses from soaring inflation, Chancellor Olaf Scholz said on Sunday, as the standoff over Russian gas and oil exports ramped up.

Analysts said that the spending plans did not suggest bond issuance from the euro zone’s benchmark issuer was about to surge.

Commerzbank rates analyst Rainer Guntermann said the spending number was bigger than anticipated.

“Yet, the bulk of this is not made up of new expenditures but rather a redistribution of inflation-driven revenues as well as measures for the next years,” he said.

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Reporting by Dhara Ranasinghe, editing by Karin Strohecker and Angus MacSwan

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