UPDATE 1-Budget deadline pushes up Italy's bond yields
Borrowing costs across the euro area also edged up as investors absorbed new bond supply from Italy, Germany and the Netherlands.
Italy sold 5.5 billion euros ($6.19 billion) worth of Italian debt, meeting the Treasury's target.
That helped limit a rise in Italian bond yields, but markets remained on edge. Rome has until the end of Tuesday to present a new 2019 budget to the European Commission or risk facing disciplinary action over its expansionary fiscal plans.
The Commission rejected Italy's draft fiscal plan last month and has threatened to impose penalties if it is not revised to conform with EU regulations - something Rome has indicated it is unwilling to do.
"We need to see the new budget show some elements of fiscal discipline, which could come in the measures that help finance their spending plans," said Credit Agricole European fixed income strategist Orlando Green.
Italy's 10-year bond yields rose to as a high as 3.51 percent, before pulling back to around 3.48 percent - still up 4 basis points on the day.
The closely watched gap between 10-year Italian and German government bond yields widened to almost 312 bps, its widest in two weeks. "If confirmed, the unwillingness of the government to change the deficit number for 2019 will remind markets that Italy remains an important source of uncertainty in the euro zone, providing further support for core yields and preventing the 10-year BTP/Bund spread from breaking below the 300 bps threshold," analysts at UniCredit said in a note.
Euro zone policymakers have discussed using the bloc's bailout fund to stem any contagion from Italy's debt woes to other indebted countries, the European Central Bank's chief economist Peter Praet said on Tuesday.
A spokesperson for the euro zone bailout fund, the European Stability Fund, added that finance ministers have been discussing the terms of access to precautionary credit lines from their bailout fund to make the instruments more effective, but the talks are not specifically related to Italy.
Elsewhere, the Netherlands sold 635 million euros of bonds maturing in 2042 and Germany auctioned just over three billion euros of two-year debt.
Outside Italy, most 10-year bond yields were 1 to 2 bps higher on the day, with Germany's 10-year Bund yield climbing from Monday's almost two-week low around 0.38 percent . ($1 = 0.8890 euros)
(Reporting by Dhara Ranasinghe, editing by Jane Merriman, Larry King )
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