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UPDATE 1-Euro, bond yields rise as ECB takes step toward QE exit

(Updates throughout)

LONDON, March 8 (Reuters) - The euro and government bond yields in the single currency bloc rose on Thursday after the ECB dropped a promise to increase bond buys if needed, taking a baby step towards dialing back its extraordinary monetary stimulus.

Keeping its broader policy unchanged, the ECB said it could still extend its 2.55 trillion euro ($3.16 trillion) bond purchase scheme beyond September if needed but omitted a reference to bigger purchases, a signal that it remains on track to end a three-year-old stimulus scheme before the end of 2018.

"It's not a major change in itself in that nobody was expecting an increase in asset purchases anyway," said Mizuho rates strategist Antoine Bouvet.

"But the market is concerned that the implication could be that the ECB is ready to move rates earlier than what is currently priced in."

The move came as a surprise to markets, sending both the euro and government bond yields higher.

Europe's single currency erased earlier losses and rose back above $1.24 after the ECB decision.

The euro, which was down 0.3 percent at $1.2378 before the announcement, firmed to the day's high of $1.2431 before easing back 0.1 percent to $1.2409.

Government bond yields meanwhile rose across the region and five-year bonds bore the brunt of the selloff, reflecting their sensitivity to rate-hike expectations. Money market futures also sold off as investors ratcheted up their rate-hike bets.

Both German and French five-year bond yields rose to two-week highs and were up 4-5 basis points on the day .

Banking stocks, which benefit from prospects of tighter monetary policy, however, spiked higher following the ECB's decision. The euro zone banking index hit a fresh day high, up 0.6 percent, while the bank-heavy Italian FTSE MIB index was up 0.6 percent.

The pan-regional STOXX 600 index was up 0.2 percent although the export-oriented German DAX index fell 0.4 percent, above its daily low.

The drop in the ECB's easing bias also spilled over to other markets.

British government bond futures extended losses by around 15 ticks to hit a session low. They were last down 26 ticks on the day at 121.00.

Having bought bonds for three years to depress borrowing costs, the ECB said it could still extend the purchases beyond September if needed but omitted a long-standing reference to increasing them -- a largely symbolic step that is seen as a precursor to a broader policy revision later this year.

Focus now turned to ECB President Mario Draghi's news conference at 1330 GMT, which will include the ECB's latest economic projections.

"We expect Draghi to take a dovish stance to offset any lingering nervousness in the markets that the Governing Council is changing its forward guidance," said Antje Praefcke, a currency strategist at Commerzbank in Frankfurt.

"The dropping of the easing bias is consistent with recent political and economic developments." (Reporting by the London Markets Team; editing by Sujata Rao; Editing by Toby Chopra)