Looking to calm investor nerves, the Italian government sought to remove one of the friction points, reaching a deal on who should fill two key positions which carry great influence over the economy.

Meanwhile, Deputy Prime Minister Luigi Di Maio denied newspaper reports that he had demanded Economy Minister Giovanni Tria resign unless he backed some pivotal appointments.

But the latest developments appeared to have no significant impact on bond markets, with Italian bond yields still higher on the day, though stock markets did recover some of their losses.

"It has been said that the finance minister is a counterbalance to the eurosceptic side of the government, and this story shows it's the deputy prime ministers calling the shots," said ING senior rates strategist Benjamin Schroeder.

"That means there is less conviction going forward that the finance minister will be able to rein in these two on issues such as the budget, and that's what's driving this volatility."

Several newspapers reported earlier on Friday that the two deputy prime ministers had issued an ultimatum to Tria over backing the government's nominees for top, vacant positions.

Shortly after Di Maio's denial, sources said a compromise deal had been reached over two of the posts -- with Fabrizio Palermo set to become CEO of state lender Cassa Depositi e Prestiti (CDP) while seasoned civil servant Alessandro Rivera will take on the role of director-general of the Treasury.

Despite the news, bonds and stocks remained weaker, with worries about the government's position on euro membership also weighing on market sentiment.

According to a report in Italian daily Corriere della Sera, the head of the budget committee in Italy's lower house of parliament, Claudio Borghi, said he was certain the country would come out of the euro sooner or later.

Italy's two-year bond yield was up eight basis points at 0.64 percent IT2YT=RR, set for its biggest one-day rise in two weeks.

Ten-year bond yields were 8.5 bps higher at 2.59 percent - pushing the gap over German Bund yields DE10YT=RR to 222 bps from around 218 bps late Thursday.

To view a graphic on Italian yields and spreads over German yields rise, click: reut.rs/2L8eJcG

"The fact that Tria is entering on a collision course with the two leaders of Italy's government forces has put (investors) on alert," said Marco Vailati, head of research and investments at Cassa Lombarda.

"A resignation would obviously be traumatic. The market reaction is logical, even though (the sell-off) could be seen as a buying opportunity should the whole thing turn out to be a journalistic exaggeration," he added.

As Italian bonds sold off, the Italian FTSE MIB equity index .FTMIB fell 0.5 percent, underperforming the European market , before recovering some of the losses. It was set to close the day down 0.2 percent.

Political noise in Italy did not seem to have a noticeable effect on the euro.

But the single currency rose half a percent on dollar weakness later in the session after U.S. President Donald Trump on Friday dug in on his criticism of the Federal Reserve's policy on raising interest rates.

However, Trump's comments failed to move bond markets, with U.S. Treasury yields remaining bps higher on the day by about 4 basis points; a move that runs contrary to any suggestion that the Fed could be moved by Trump's rhetoric. US10YT=RR DE10YT=RR

Most euro zone bond yields were also higher on the day, with benchmark German 10-year yields -- the benchmark for the region -- up 4 bps at 0.37 percent, its highest in a month. DE10YT=RR