UPDATE 1-Flat lining economy bruises Italy's government bonds

Italian government bonds were hit on Tuesday by data showing the country's economy flatlined in the third quarter of the year, while a 5.5 billion euro auction pushed yields even higher.

Italy's economy ground to a halt in the third quarter, data showed on Tuesday, as both domestic demand and trade flows failed to spur any growth, while euro zone growth disappointed for the same period.

Yields on Italian government bonds were five to 12 basis points higher on the day, extending an earlier rise.

"It's a surprisingly weak Italian GDP number, it kind of puts an end to the expectations that the government has that they can base their budget on their current growth projections," said ING rates strategist Benjamin Schroeder.

"It highlights how out of touch some of the assumptions of the Italian government were on this backdrop."

The Italian government assumes economic growth of 1.5 percent in 2019, higher than the 1.1 percent growth projected by the European Commission.

Those economic projections are the base for Rome's plans to increase the budget deficit next year. Last week, the European Commission rejected Italy's draft 2019 budget because it broke EU rules.

Italy's 10-year government bond yield was up 10 bps at 3.44 percent, having been as low as 3.32 percent earlier in the session.

The closely watched spread over yields on German government debt was at 307 bps, having narrowed on Monday to around 287 bps on relief that Standard & Poor's did not downgrade Italy's credit rating after a review on Friday.

Fresh supply added to the upward pressure on Italian bond yields.

Italy's Treasury raised the top planned amount of 5.5 billion euros ($6.2 billion) over three bonds.

Ten-year yields, however, rose at the auction to 3.36 percent, the highest auction level since February 2014. Five-year bond yields hit 2.58 percent at auction, the highest since December 2013.

Outside Italy, most 10-year bond yields in the euro area were flat to little changed on the day.

In Germany, the euro zone's benchmark bond issuer, 10-year bonds yields were steady at 0.38 percent after briefly rising above 0.40 percent.

Data showed the euro zone economy grew a weaker-than-expected 1.7 percent in the third quarter compared with 2.2 percent expansion in the previous quarter, adding to a view that an unwind from the European Central Bank's ultra-easy monetary policy will be slow. (Editing by Alison Williams)

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