Benchmark 10-year Italian yields jumped 6 basis points to 1.94 percent in early trading and the spread between Italian debt and its German counterpart stretched to its widest in six weeks at 138 basis points.

Following inconclusive elections, the anti-system 5-Star movement had been signalling for weeks it was ready to form a coalition with the anti-immigrant League, but not with the latter's electoral ally, former prime minister Silvio Berlusconi.

Berlusconi gave way late on Wednesday, accepting a demand from 5-Star that his Forza Italia party take no part in the next government.

"With Berlusconi out, an anti-establishment government is one step closer to reality and while both these parties may have their differences, they are united in at least one thing: more fiscal stimulus," said Antoine Bouvet, a rates strategist at Mizuho in London.

Yields also rose at the short end of the Italian curve with two-year bond yields rising 3 basis points to a two-month high at minus 0.13 percent.

The spread between two-year and ten-year bonds widened to a six-week high of 206 basis points.

Outside the government bond markets, moves were muted with Italy's five year credit default swaps pushing one basis point wider to 95 basis points while the euro edged higher after suffering some recent losses.

Though a government led by 5-Star might not be the market's ideal outcome, Morgan Stanley strategists said spreads should move higher only if there was a sharp pick-up in bond issuance to fund any fiscal stimulus plan.

With some European markets closed for holidays, focused shifted to Britain where the Bank of England is expected to hold rates steady, a remarkable turnaround from last month when the market viewed a 25 basis points rate hike as a done deal.

While market expectations of a rate hike have been pushed back to August, analysts will be closely watching policymakers for any changes in language or voting patterns.

With odds of a August Bank of England rate hike at 50 percent, ING strategists said a combination of a third vote in favour of a rate hike and comments referring to a 'transitory' soft patch would lift sterling higher and push UK yields up.

Two-year gilt yields edged 1 basis point up to 0.83 percent.

U.S. inflation data is also likely to help keep any large market moves in check by strengthening expectations that the Federal Reserve will raise interest rates at least three more times this year.

With both core and headline U.S. CPI expected to show some acceleration and oil prices up by 7 percent over the last three sessions, a flare-up in prices should push yields higher.