March 13 (Reuters) - The gap between Italian and German

yields hit a 26-month low on Wednesday while the euro area's

bond prices edged higher after falling the day before, with

markets still betting on 95 basis points of European Central

Bank rate cuts in 2024.

Bond prices move inversely to yields.

Since the ECB policy meeting last week, investors have

assumed that the central bank will keep rates at the current

levels until June and will gradually cut after that point.

Yields on both sides of the Atlantic rose on Tuesday after

U.S. inflation figures came in slightly above expectations,

raising concerns that the Federal Reserve may not be able to cut

interest rates as soon as investors expect.

The spread between Italian and German 10-year yields - a

gauge of risk premium investors ask to hold bonds of the euro

area's most indebted countries - enjoyed a strong rally this

year as appealing returns and appetite for risky assets boosted

demand for Italian government bonds.

JP Morgan flagged, in a research note, that the yield gap is

at levels seen before the ECB tightening cycle started, arguing

that "the recent tightening, intra-EMU spreads, especially

Italian spreads, are screening expensive relative to other Euro

credit spreads".

The gap between Italian and German yields was

last at 127 basis points after hitting early in the session

123.80 bps its lowest level since mid-January 2022.

"The air is getting thin around our 125 bps target for 10y

spreads, as the ISDA basis (which captures Italy's specific

credit factors) is running into very hard resistances," said

Michael Leister, head of interest rates strategy at Commerzbank.

Germany's 10-year yield, the benchmark for the

euro zone, was last down 2 bps at 2.31%.

The ECB will probably start cutting rates between April and

June 21, as the "victory" against inflation is in sight, French

central bank head Francois Villeroy de Galhau said.

Money markets discounted 95 bps of ECB rate cuts in 2024

while almost entirely pricing a first move by

June and almost no chance of a rate cut in April.

"The longer rates remain restrictive and the slower the ECB

is to cut, the bigger the danger that some economic harm becomes

apparent," said Chris Attfield, European rates strategist at

HSBC, flagging that the ECB assumes unemployment will not rise

and that growth will pick up in the second half of 2024.

"The early signs of stress are already visible in January's

survey of bank lending, which fell as high rates suppressed

credit demand," he added. "These tail risks are not

significantly priced into the market at present."

The ECB will announce later in the session the outcome of

discussions about its Operational Framework Review, a technical

but vital exercise that will set rules for how it provides

liquidity to commercial banks in the coming years.