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UPDATE 1-South Europe bonds lag as euro hardliners bound for German government

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* "Peripheral" spreads widen after Merkel support drops

* Coalition could prove roadblock to euro integration

* ECB members including Mario Draghi due to speak on Monday

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

LONDON, Sept 25 (Reuters) - Southern European government bonds underperformed on Monday after an unexpectedly weak election result for Germany's Angela Merkel led to concerns about the emergence of a more hardline stance towards the euro zone in the bloc's largest economy.

Merkel secured a fourth term as chancellor and said she expected to form a coalition by Christmas.

But she was weakened by a surge in support for the far right and investors were unsettled by the possibility that she may have to form a coalition with the pro-business Free Democrats (FDP) and Greens.

"The pro-market Free Democrats, as well as part of the CDU/CSU, oppose deeper financial integration in the euro area," analysts at Morgan Stanley said in a note.

"In exchange for debt relief, the FDP would likely insist that Greece leaves the euro. This suggests headwinds to the euro and periphery."

Lower-rated Spanish, Italian and Portuguese government bonds sold off in early trade and 10-year yields rose 3 basis points across the board at the start of the session.

They clawed back the losses as the session wore on, but underperformed on a day when higher-rated euro zone government bond yields fell.

The Italy-Germany 10-year government bond yield spread hit its widest in 2-1/2 weeks at 168 basis points at one stage.

The yield on Germany's 10-year government bond, the benchmark for the region, hit a 10-day low of 0.42 percent, down 3 basis points on the day.

Yields on most other highly rated government bonds, such as those of Austria and the Netherlands, also fell.

"The FDP will insist on red lines in the plans for deeper euro integration ahead of Macron's keynote speech tomorrow," Commerzbank analyst Christoph Rieger said.

The single currency was down 0.4 percent at $1.1900.

The result of the German election on Sunday could stoke uncertainty among business, the chief economist of the Ifo economic institute said on Monday after business confidence deteriorated unexpectedly in September.

Clues to the outlook for monetary policy in the bloc may be forthcoming with a string of European Central Bank members due to speak later on Monday.

Vice President Vitor Constancio is set to be followed by fellow Governing Council member Benoit Coeure; ECB President Mario Draghi makes an introductory statement in the European Parliament at 1300 GMT.

Euro zone inflation data due out at the end of the week will also be closely watched.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.bi z / c m s / ? p a g e I d = l i v e m a r k e t s

(Reporting by Abhinav Ramnarayan; Editing by Janet Lawrence)