UPDATE 2-Euro zone bond yields rise as ECB seeks damage control

Yoruk Bahceli and Tommy Wilkes

* German yield rises as stocks recover, more talk of govt spending

* Italian yields briefly hit new high, then fall back

* ECB disappointed markets with Thursday's stimulus package

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

LONDON, March 13 (Reuters) - Euro zone bonds yields jumped on Friday as investors' expectations grew for fiscal stimulus in the region to combat the coronavirus pandemic.

Italian 10-year borrowing costs were set for its biggest weekly jump since 1994, according to Refinitiv data, after having their worst day since the euro zone debt crisis on Thursday after a comment by European Central Bank (ECB) chief Christine Lagarde spooked the market.

Germany's KfW state development bank has roughly half a trillion euros in available to help support Europe's largest economy, which risks being stricken by the outbreak, the Economy Minister said on Friday.

The European Union will establish a 37 billion euro investment initiative to combat the impact of the flu-like virus, and is ready to activate a clause in fiscal rules that would allow a suspension of budget commitments by countries most affected by the crisis.

The benchmark German 10-year yield rose 16 basis points to -0.58%, a 10-day high, helped by a rebound in stocks following the worst day on record for European shares on Thursday.

"We saw the German government, so far had resisted fiscal easing, but today's response.. that's been hitting Bunds particularly hard," said TD Securities rates strategist Pooja Kumra.

Analysts also said that investors were being forced to sell even higher rated so-called "core" euro zone bonds - which had taken a back seat on Thursday - to maintain liquidity.

"The market is still volatile. A lot of investors still need liquidity and they have to sell even safe havens," DZ Bank's Fellechner said.

Analysts said likely fiscal stimulus would keep upward pressure on government bond yields.

Italy's bond market remained under pressure, after a comment by ECB President Lagarde on Thursday that the central bank was not there to "close spreads" hit peripheral government bond markets hard.

Italy's 10-year bond yield has soared 75 basis points this week and on Friday was set for its biggest weekly jump since 1994, according to Refinitiv data.

It rose more than 20 basis points to nearly 2% in early trading, the highest level since July, before falling back as policymakers sought to calm investors' fears.

Italian yields were last up 10 basis points at 1.83%, after central bank chief Ignazio Visco said the ECB could focus its bond purchases on particular countries if necessary.

The gap between Italian and German 10-year bond yields , effectively the risk premium the former pays on its debt, had pushed out to its widest since June at around 261 bps on Thursday. It last stood at 236 bps.

ECB policymakers shifted to damage control on Friday, with chief economist Philip Lane saying they would "not tolerate any risks to the smooth transmission of our monetary policy in all jurisdictions of the euro area."

"Lane's comments today are picking up the pieces of the damage done yesterday," said Christoph Rieger, head of rates and credit research at Commerzbank. "Lagarde has no experience with markets and that became obvious yesterday."

Inflation expectations proved volatile on Friday. After rising as high as around 0.96%, they edged back down to 0.92%, although remained above record lows below 0.90% hit on Thursday.

(Reporting by Yoruk Bahceli and Tommy Reggiori Wilkes; Additional reporting by Dhara Ranasinghe; Editing by Larry King and Alex Richardson)