By Dhara Ranasinghe
LONDON (Reuters) - Yields on lower-rated euro zone government bonds rose sharply on Monday after data showing inflation in Germany hit a 3 1/2-year high stoked talk of an unwinding of monetary stimulus, though German yields fell as investors sought safety.
French government bond yields hit 16-month highs, facing additional upward pressure from uncertainty surrounding upcoming presidential elections, a key political risk event for Europe.
In Greece, short-dated bond yields soared to a one-month high around 10 percent <GR2YT=TWEB> on worries about whether the International Monetary Fund will participate in a bailout program for the indebted southern European country.
An unexpectedly high inflation figure from the German state of Saxony triggered fresh selling across euro zone bond markets. Consumer prices in Saxony rose by 2.3 percent year-on-year in January.
The European Central Bank targets inflation at close to but less than 2 percent.
Nationwide inflation data released at 1300 GMT confirmed that German annual inflation increased further in January to 1.9 percent, but fell short of investors' expectations.
The yield on 10-year German government bonds <DE10YT=TWEB> were 2 basis points lower at 0.45 percent at 1615 GMT, having hit a high of 0.495 percent earlier in the session.
"There was a sharp selloff after the Saxony numbers came out but the CPI figure for Germany as a whole was weaker than expected so we have had quite an eventful session," said Mizuho strategist Antoine Bouvet.
"That combined with stock market weakness pushed German yields back down."
European stocks <.STOXX> fell over 1 percent on Monday, pulled lower by commodity and bank shares.
ING senior rates strategist Martin van Vliet said the taper talk is a double whammy for lower-rated South European bonds, viewed as key beneficiaries of ECB bond-buying stimulus.
Italy's 10-year bond yield was up 8 basis points at 2.31 percent <IT10YT=TWEB>, its highest since July 2015, and 186 bps above German equivalents. Portuguese yields hit their highest level in about a year <PT10YT=TWEB>.
Austrian and Irish bond yields <AT10YT=TWEB> <IE10YT=TWEB> also hit multi-month highs before pulling back.
A key gauge of the euro zone's long-term inflation expectations, the five-year, five-year breakeven forward rate, held near its highest level in over a year <EUIL5YF5Y=R>.
The ECB will probably first review its policy stance in June but stop short of any decision on winding down its huge economic stimulus program, ECB rate setter Ewald Nowotny said on Monday.
FRENCH, GREEK JITTERS
In France, additional unease over looming presidential elections pushed 10-year bond yields 7 bps higher at one stage to 1.12 percent <FR10YT=TWEB>, the highest level since September 2015, though it was back down to 1.05 percent at 1630 GMT.
The gap over top-rated German Bund yields exceeded 60 basis points for the first time in three years.
The chance of one of France's two established political parties regaining power in May's vote was seen diminishing after the Socialists on Sunday picked a hard-left candidate and as Conservative leader Francois Fillon battled to contain a scandal over fake pay.
"A widening in French bond spreads is very much related to political events," said DZ Bank rates strategist Daniel Lenz.
Elsewhere, Greece's two-year bond yield soared to a one-month high at around 10 percent <GR2YT=TWEB> on worries about whether the International Monetary Fund will participate in a bailout program for the indebted southern European country.
(Additional reporting by Abhinav Ramnarayan, editing by Pritha Sarkar)