UPDATE 1-Italian bond yields volatile before budget deadline

Italian bond yields fell on Wednesday, reversing gains earlier in the session, as the market looked for clues ahead of this week's budget deadline.

Analysts said trading was volatile ahead of a speech by economy Minister Giovanni Tria scheduled for 10:30 a.m. CET and a cabinet meeting on Thursday.

Yields on Italian bonds were as much as seven basis points lower after rising briefly after the open of European markets. Italy's five-year bond yields were four bps lower at 1.83 percent and its 10-year was five bps lower at 2.84 percent.

"The market is reacting not to whether (Deputy Prime Minister Luigi) Di Maio is able to extract additional funding for his basic income programme, but whether or not he is likely to suggest the coalition is doomed," said Matt Cairns, rates strategist at Rabobank.

Di Maio said on Wednesday that a 2019 deficit exceeding 2 percent of output was not out of the question, though he added that the ruling coalition would be responsible with the budget.

The comments come after overnight reports that Di Maio had threatened not to support the budget unless it accounted for key demands, including a minimum income for the poor and unemployed.

Di Maio and Matteo Salvini, his ruling coalition partner, have pushed for a broad range of populist measures to be included in this year's budget, which has unnerved investors.

The government made up of the 5-Star Movement and League party, must approve its 2019 public finance and growth targets on Thursday. Economy Minister Giovanni Tria, who is a member of neither party, is pushing to keep the deficit below 2 percent of the gross domestic product next year.

Investors hope a cabinet meeting scheduled for Thursday will end months of speculation, though analysts warn that while the headline figure may look palatable, the devil will be in the detail of the budget.

"It seems that the agreement will be 2 percent," said Rainer Guntermann, rates strategist at Commerzbank.

"This level should be priced in, but it is not so much about the numbers per se, then how realistic they are in terms of economic growth and tax assumptions. The question is, is this achievable in the long term, is there a risk of a higher deficit?"

Elsewhere, German bond yields remained just below highs reached on Tuesday. Germany's 10-year, the benchmark for the region, opened at around 0.54 percent, down around 1 bp.

Eurozone bond yields opened 1 to 2 basis points lower as markets awaited the outcome of a two-day meeting of the U.S. Federal Open Markets Committee.

The probability the Fed will raise its benchmark overnight lending rate by a quarter of a percentage point on Wednesday, in what would be its third increase this year, is nearly 95 percent, based on an analysis of fed fund futures contracts by CME Group.

Investors are bracing for higher interest rates globally as major central banks unwind massive stimulus injected into world markets to cope with the financial crisis. U.S. 10-year yields rose to a four-month peak on Tuesday, then edged down to 3.09 percent in early trade.