(Refiles to fix typo in paragraph 4)
* U.S. bonds underperform as June Fed rate hike expected
* U.S./UK spread at highest in 34 years as UK economy struggles
* Italian yields edge up further on early election jitters
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Abhinav Ramnarayan
LONDON, May 1 (Reuters) - The gap between U.S. and German 10-year benchmark bond yields was a shade off its widest level in nearly three decades on Tuesday as the economic and monetary policy outlooks of the two regions start to take different paths.
In thin trading on Tuesday with much of Europe on May Day holiday, U.S. 10-year Treasury yields rose above 2.96 percent briefly, extending the gap over the German equivalent.
The dollar was its strongest against a basket of currencies since early January on increased expectations that the U.S. Federal Reserve will raise rates three more times this year to add to the one hike already done.
Core euro zone bonds, on the other hand, have picked up demand in recent days since a European Central Bank meeting on expectations that policymakers will adopt a relatively cautious stance.
“Higher U.S. core PCE inflation and Wednesday’s FOMC meeting should pave the way for a June hike (from the Fed),” Commerzbank analysts said in a note. However, subdued inflation on the other side of the Atlantic, along with redemptions and other technical factors, should stabilise European government bonds, they added.
The gap between 10-year German and U.S. bond yields was at 240 basis points, less than a basis point off the widest level since March 1989 touched last week.
Though this spread does not account for the different valuations of the currencies of either region, it still indicates how differently investors view the two regions in terms of how far central banks have to go in removing post-crisis stimulus.
The European Central Bank still buys 30 billion euros of bonds a month as part of its stimulus programme and rate hikes are still far away by investors’ reckoning, whereas the Fed is already running down its quantitative easing scheme.
In addition, the gap between British and U.S. 10-year government bond yields hit its widest since 1984 on Tuesday, reflecting sharp shifts in interest rate expectations in the two countries in recent days.
Most euro zone bonds were roughly unchanged on the day, Italian yields rose a touch, having jumped 3-5 basis points across the curve on Monday on political jitters.
On Tuesday, the Italy/Germany 10-year bond yield spread reached its widest in two weeks at 123 basis points following Tuesday’s headlines that raised the possibility of an early election.
5-Star leader Luigi Di Maio called for early elections in June, saying efforts to form a coalition after last month’s inconclusive vote had gone nowhere.
Reporting by Abhinav Ramnarayan, Editing by Mark Heinrich
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