LONDON, Nov 2 (Reuters) - Euro zone government bond yields retreated on Tuesday, as markets appeared to win a reprieve from a brutal selloff that has driven borrowing costs sharply higher on expectations for higher inflation and interest rates. Bond yields across the bloc have shot up since European Central Bank chief Christine Lagarde last week disappointed expectations of a firm push back against aggressive market pricing for two 10 basis point rate hikes next year, and which is at odds with the ECB’s policy guidance. But a calmer tone took hold in early trade, perhaps as a note of caution set in ahead of a two-day U.S. Federal Reserve meeting that kicks off later in the day. In addition, short-dated Australian government bond yields fell after the Reserve Bank of Australia took a major step towards unwinding extraordinary pandemic stimulus but pledged patience and rejected market talk of a rate hike as early as May 2022. Germany’s benchmark 10-year Bund yield, which rose 10 bps in October, was down 2.5 bps on the day at -0.12% and holding below roughly 2-1/2 year highs hit last week at -0.065%. Southern European bonds, which bore the brunt of the selloff in the wake of last Thursday’s ECB meeting, outperformed. Italy’s 10-year bond yield, for instance, was down almost 8 bps on the day at 1.15%, off more than one-year highs touched on Monday. That squeezed the gap over safer German peers to around 126 bps after it widened to around 135 bps on Monday -- the widest in a year. “We think the widening of periphery spreads and in particular of the BTP-Bund spread has been too sharp and too quick,” analysts at UniCredit said in a note, adding that they expected spread tightening in the next few weeks given Italy’s positive economic outlook and ongoing bond buying stimulus by the ECB. “Undeniably, the chance of high volatility in the rates universe continuing to prevail in the next few days is sizeable, making it tricky to guess the best entry point for a BTP-Bund tightening trade,” the UniCredit note said. Reporting by Dhara Ranasinghe; Editing by Sherry Jacob-Phillips