* Italian 10 and 30 year yields reach four-year highs
* Contagion with Portugal and Spain yields also higher
* Money markets push interest rate hike bets back to Oct. 2019
* Italy / Germany most widely used in 5-1 / 2 years
* Eurozone periphery government bond yields tmsnrt.rs/2ii2Bqr (Adds ECB rate hike expectations, quotes, background, updated prices)
By Abhinav Ramnarayan
LONDON, October 19 (Reuters) – Italian government bond yields hit the four-year high on Friday and extended their gains after the European Union criticized the draft budget of Rome, while money markets insisted that EU-Italy Tug-of-war could force the ECB to delay its first rate hike.
German Bunds, which were considered safe assets in the Eurozone, recovered. But Portuguese and Spanish bonds, which have so far been resilient to the Italian budget debacle, also sold off, with some analysts pointing out that this was the first sign of contagion from Italy.
Italy's Prime Minister defended the Expenditure on Expenditure on Thursday, lifting criticism from Brussels as the European Commission tightened pressure on a draft calling for an "unprecedented" violation of EU budget rules.
The EU authorities will send a formal letter of warning, which could lead to Brussels rejecting the draft before the end of the month.
While it is not uncommon for the EU to ask Member States to clarify the budgetary issues, the transmission of formal letters and the tone of comments are particularly strong, analysts said.
"The letter was sharper than usual, describing the budget as an" obvious departure "from past commitments on an unprecedented scale," said Deutsche Re's research strategist Jim Reid to clients.
"Next week is likely to further escalate the situation in the face of these tensions, an ECB meeting where little sympathy is expected, and also the forthcoming measures by the rating agencies," he added.
S & P Global will review Italy's rating next Friday, October 26, while Moody's said it would probably complete a review of Italy's rating at the end of October.
A downgrade would bring Italy a score away from junk status and the possible loss of hundreds of billions of cash flows that go with an investment grade rating.
Italy's benchmark yield on 1
The 10-year bond yield in Germany was 332 basis points, just under 5-1 / 2 -Year high on Thursday.
Italy's 30-year bond yield hit a 4½-year high of 4.22 percent before dropping to 4.09 percent, still down two basis points a day and 20 basis points versus Wednesday and Thursday. Meanwhile, Eurozone money markets are beginning to postpone the timing of the European Central Bank's first interest rate hike to October 2019.
After the yield curve was fully priced in on Monday in September 2019, financial markets now only hint at a 75 percent chance of a rate hike by the ECB by 10bps in September 2019 and a rate hike in October, a bet that a The dispute between Italy and the EU could force the ECB to be more cautious.
The budget struggles put an end to the recent upswing of the euro. The single currency fell to a two-month low of $ 1.14325 on Friday, falling more than a percent this week.
The Italian sell-off drove investors into German government bonds with yields of 0.407 percent, the lowest in over a month. German yields are now around 16 basis points below this high.
Spanish and Portuguese ten-year government bond yields rose 3-4 basis points to a new high for the year of 1.77 percent and a five-month high of 2.08 percent.
Emphasized the Commerzbank strategists The rise in Spanish yields as a sign of contagion from Italy, called it "textbook crisis dynamics" in a note. (Report by Abhinav Ramnarayan Editorial staff of Sujata Rao and Matthew Mpoke Bigg)