ECB rate hike unease keeps euro zone bonds on edge

LONDON, May 24 (Reuters) - Italy's 10-year bond yield hit a two-week high and Greek yields rose to their highest levels since March 2020 for a third straight session on Tuesday, as the European Central Bank's chief again reminded edgy markets that rate hikes are coming.

Christine Lagarde said on Tuesday she saw the ECB's deposit rate at zero or "slightly above" by the end of September, implying an increase of at least 50 basis points from its current level.

The comments came a day after Lagarde accelerated a policy turnaround that has seen her go from all but ruling out a move this year to pencilling in several hikes. The ECB's key depo rate is at -0.50%.

Unease that the ECB is now heading fast towards the stimulus exit given record high inflation was most felt in southern Europe markets, the biggest beneficiaries of ECB largesse in recent years.

Italy's 10-year bond yield touched its highest level in two weeks at 3.075%, up 4 basis points on the day, and keeping the closely watched gap over the safer German Bund yield above 200 bps.

Greece's 10-year bond yield rose to 3.77%, its highest level since March 2020 - when the COVID-19 outbreak triggered market turmoil. Spanish and Portuguese 10-year bond yield gaps were not far off their widest levels since 2020 .

Germany's 10-year Bund yield was marginally lower on the day at 1.02%, having traded about 3 bps lower before Lagarde's latest remarks.

"The ECB is trying to convey the message of gradual rate hikes," said Nordea chief analyst Jan von Gerich.

"In general the message is hawkish and she (Lagarde) has opened the door to bigger hikes further out."

There was also some focus on the release of the preliminary forward-looking Purchasing Managers Index (PMI) of business activity across euro area economies.

France's May flash composite PMI - which comprises both the services and manufacturing sectors - was at 57.1, down from 57.5 in April, and below a forecast for 57.0.

Germany's flash composite PMI, beat the 54.0 expected by analysts, nudging up to 54.6 from 54.3 in April.

PMI readings above 50 signal growth in activity.

Elsewhere, Austria started the sale of its first ever 'green' bond which will price later on Tuesday, according to a lead manager memo seen by Reuters. (Reporting by Dhara Ranasinghe; Editing by Susan Fenton)