Feb 24 (Reuters) - Euro area benchmark Bund yields edged

up on Monday as the outcome of German general elections

supported expectations for pro-growth policies, though

uncertainty remained over potential reforms to the debt brake

and increased fiscal spending.

Germany's likely next chancellor, Friedrich Merz, will start

trying to form a coalition government on Monday after his

conservative bloc won a national election that saw far-right and

far-left parties hoover up support from disaffected voters.

"We expect a two-party coalition between the (conservative

bloc) CDU/CSU and the centre-left SPD to enact some pro-growth

supply-side reforms," said Holger Schmieding, chief economist at

Berenberg Bank.

He argued populist parties from the political fringes, such

as Alternative for Germany (AfD) and the Left party, "can veto

any loosening of the debt brake enshrined in the constitution."

Investors have pinned hopes on a new government reforming

the so-called debt brake to increase fiscal spending and boost

the economy, especially given the pressure from the U.S.

government for European countries to pay more for defence.

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

the wider euro zone, was up one basis point (bp) at 2.47%.

The Left has campaigned for lowering defence spending, but

it is in favour of higher infrastructure investments and

abolishing the debt brake.

"There could be a cross-party consensus with the Left on

setting up an off-budget infrastructure fund or exempting

infrastructure investment from the debt brake to create more

room for defence spending in the core budget," creating some

"room for manoeuvre," according to Deutsche Bank.

The 2-year yield, more sensitive to European

Central Bank policy rates, was flat at 2.10%.

"I think there will be more spending on infrastructure

investments and defence no matter what happens with the debt

brake," said Carsten Brzeski, global head of macro research at

ING. "That should increase the Bund supply."

Business morale in Germany unexpectedly stagnated in

February.

"The election results are consistent with our base case of a

pro-growth shift in economic policy under a coalition, which

would include some modest fiscal easing," said Mark Haefele,

global wealth management chief investment officer at UBS.

Merz could face lengthy and complex coalition negotiations

after a surge in support for the AfD and far-left.

"The risk that coalition building fails because the CDU/CSU

pulls out or SPD members vote down the result is significant, in

our view," said Christian Schulz, an economist at Citi.

"That could lead to either a minority government or snap

elections," he added.

Citi's Schulz highlighted the differences between the two

parties, mentioning that the CDU/CSU campaigned to enhance

competitiveness by cutting taxes for business, while SPD

campaigned for a demand boost, with another minimum wage hike

and a 100 billion euros public investment fund.

Italy's 10-year yield was up 0.5 bps at 3.56%.

The yield gap between Italian and German government bonds

was 106.5 bps.

Markets are also mulling over the European Central Bank

policy path after ECB officials recently warned about excessive

monetary easing.

Policymaker Pierre Wunsch said the euro zone faces the risk

of "sleepwalking" into excessive interest rate cuts and must be

prepared to stop lowering borrowing costs soon.

Money markets priced in an ECB depo rate at 1.95% in

December from over 2% on Friday before PMI

data as the uncertainty about the German economy weighed.