By Tommy Wilkes
LONDON, April 8 (Reuters) - Italian government bond yields rose sharply on Wednesday after European Union finance ministers failed to agree a rescue package to help economies recover from the impact of the coronavirus outbreak.
Diplomatic sources and officials said a feud between Italy and the Netherlands over what conditions should be attached to euro zone credit for governments fighting the pandemic was blocking progress on half a trillion euros worth of aid.
Heavily indebted Italy, one the countries hardest hit by the pandemic, has been lobbying for more economic support -- including some form of debt mutualisation.
The European Central Bank, which has showered the region with more cheap cash to aid a recovery and scaled up its bond-buying scheme to keep sovereign borrowing costs low, has said EU governments must ramp up their fiscal stimulus.
"There were expectations that at least they (EU ministers) would come up with a cheap compromise," Jan von Gerich, a fixed income strategist at Nordea, said.
"What we know from the leaks is that they haven't even got that agreement. It becomes very challenging for countries like Italy. The ECB doesn't want to take all the risks. They don't want to hold half of Italy's debt when the debt is unsustainable."
Officials told Reuters that the ECB had told euro zone finance ministers that the euro zone could need fiscal measures worth up to 1.5 trillion euros to tackle the economic crisis caused by the COVID-19 epidemic.
Italy's 10-year bond yield rose as much as 20 basis points in early trade, hitting its highest since March 19 at 1.748% IT10YT=RR, before slipping back.
The 2-year yield rose 22 bps but was last up 14 bps at 0.72% IT2YT=RR.
The gap between benchmark 10-year German and Italian bond yields DE10IT10=RR, a gauge of the risks investors attach to lending to Italy, rose to more than 200 basis points, at one point hitting its widest since March 20.
Nordea's von Gerich said the ECB, at least privately, would be happy for Italian yields to rise as long as the moves were not too dramatic in order to send a message to EU ministers that they needed to reach an agreement on fiscal support.
Italian yields rocketed past 3% last month but ECB actions have brought them right back down.
Other southern European bond yields were mostly unmoved, although the Greek 10-year yield climbed 6 bps to 1.89% GR10YT=RR.
German yields dipped as investors sought some safety in the region's best-rated bonds. The 10-year yield fell 2 bps to -0.335% DE10YT=RR.
Italy bond yields under pressure again IMAGEhttps://reut.rs/2XelkHo
(Reporting by Tommy Reggiori Wilkes; Editing by Dhara Ranasinghe and Alison Williams)