Italian government bonds were set for their worst day in over three months after key Italian government officials agreed a budget overnight that will see the country run a deficit in 2019 and beyond.

Italy's government on Thursday targeted the budget deficit at 2.4% of gross domestic product for the next three years, defying Brussels and marking a victory for party chiefs over Economy Minister Giovanni Tria, an unaffiliated technocrat.

"There is an accord within the whole government for 2.4%, we are satisfied, this is a budget for change," 5-Star leader Luigi Di Maio and League chief Matteo Salvini said in a joint statement after meetings with Tria.

The concern for investors is that this budget not only puts Italy at odds with Brussels, but that the anti-establishment government is not committed to tackling the country's immense debt pile.

"The 2.4% target is not consistent with an improvement in the structural budget balance and hence they seem to be on a collision course with Brussels," said ING strategist Martin van Vliet.

"And moreover for me the key issue is what they assume on the budget beyond 2019. They are seemingly leaving the path of fiscal consolidation and they may not sit well with ratings agencies."

Italy's rating is a particular concern, as the country is only two notches above the dividing line between investment grade and junk.

Italy's two-year bond yields -- which have been most sensitive to political noise in recent months -- were up 31 basis points in early trade at 1.09%.

Other Italian yields were also higher on the day, with five-year yields up 26 bps at 2.16% and benchmark 10-year yields up 17 bps at 3.08%.

At this rate, all three bonds are set for their highest rise since September 21.

The closely-watched Italy/Germany 10-year bond yield spread was at its widest in three-weeks at 256 basis points.

"We see potential for the 10-year BTP-Bund spread to reach 300 basis points over the coming two weeks - albeit being capped there due to Tria remaining on board," said Mizuho's head of rates Peter Chatwell.

"What is crucial next is the first glimpse of a reaction from the European Commission."

The euro meanwhile, dropped to an 11-day low of $1.1617 per cent, down 0.2% on the day while Italian bank shares fell more than 4%.

Other high-grade euro zone government bonds dropped as investors retreated to the safety of higher-rated government debt.

Germany's 10-year government bond yield, the benchmark for the region, was lower 4 bps at 0.49%.

Later on Friday, euro zone inflation numbers for the month of September are due out, with a Reuters poll showing that expectations are for consumer prices to have risen 2.1% year-on-year, above the European Central Bank target.

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