German yields edge higher as Lagarde gains allies for gradual tightening

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Recasts, updates prices)

By Stefano Rebaudo

May 25 (Reuters) - German government bond yields edged higher on Wednesday as European Central Bank officials supported ECB President Christine Lagarde's plan for gradual monetary tightening, while concerns about the economic outlook dampened risk appetite.

Lagarde gained key allies for her plan to raise rates out of negative territory in steady increments this summer, though one of her board members expressed some scepticism at the speed of the change she has signalled.

Flash Purchasing Managers' Indexes released on Tuesday of the euro zone's services and manufacturing sectors fell respectively well below and short of expectations.

The Fed will release the minutes from its May 3-4 policy meeting at 1800 GMT, while investors' primary focus in Europe is how the ECB will move in July.

Dutch central bank chief Klaas Knot, among the most conservative members of the ECB who recently advocated a 50 bps rate hike in July, said he supported Lagarde's proposed schedule.

Recent comments from the ECB chief broadly confirmed expectations about future rate hikes, including a 25 bps move in July, analysts said.

"If they raise rates by 50 bps, instead of the 25 bps the market currently expects, they would probably trigger a new bearish repricing in the bond market," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

Germany's 10-year government bond yield, the benchmark for the euro zone, rose 0.5 basis points (bps) to 0.96%, after falling 7 bps on Tuesday.

Maxia forecast the 10-year Bund yield would fluctuate around 1% before the next ECB policy meeting on June 9.

Lagarde has advocated a gradual approach to monetary tightening while asserting the ECB is free to react to the effects on the economy and the inflation outlook as rates rise.

"Lagarde's forward hikes serve as a tranquiliser for euro rates markets. Despite ongoing noise from the hawks, markets continue to focus on her guidance of steady 25 bps hikes," said Michael Leister, head of interest rates strategy at Commerzbank, in a note to clients.

Italy's 10-year government bond yield fell 2.5 bps to 2.948% , with the spread between Italian and German 10-year yields at 199 bps.

Tightening yield spreads between the core and peripheral bonds usually reflect expectations of a more dovish stance from the ECB, as the most indebted countries benefit the most from monetary support.

Allianz Global Investors' Maxia said he expected the Italian-German spread to stay close to 200 bps before next ECB policy meeting.

Dutch central banker Knot argued there was no need for concerns with yield spreads at the current levels.

(Reporting by Stefano Rebaudo, editing by John Stonestreet and Catherine Evans)

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