(Adds details, updates prices) Nov 12 (Reuters) - Short-dated German bond yields fell sharply on Friday even as money markets priced two full European Central Bank rate hikes by the end of next year. The bloc’s bond markets have swung in recent weeks, with a focus on when major central banks will start to hike rates as markets fear inflation is proving less transitory than initially expected. Ramping up rate hike bets after the ECB’s October policy meeting, markets calmed down once policymakers pushed back more strongly against the pricing and the Bank of England did not deliver an expected rate hike, a week after. But U.S. October inflation numbers came in higher than expected on Wednesday, raising questions about how quickly the U.S. Federal Reserve might need to act. After moving back to price in a full ECB hike by September 2022 on Thursday, Eonia futures dated to the bank’s December 2022 meeting priced two full rate hikes by then, compared to one hike earlier this week. “I’ve only got one word for that, which is nonsense,” said Peter Chatwell, head of multi-asset strategy at Mizuho. “But there’s a reason the market is able to price in nonsense, because these levels of inflation are not going to turn around until mid Q1 of next year. Until then the market has to price a fat tail of potential interest rate outcomes.” But German short-dated yields fell sharply, with two and five-year yields down 5 bps by 1522 GMT. Normally, money market rate hike bets and short-dated bond yields would be expected to move in the same direction as the latter are sensitive to policy rates. “We learned (last week) that ECB isn’t in a hurry to raise rates... (the) Bund is the benchmark for collateral in the euro zone and everyone is trying to get their bonds (they sold in recent weeks) back,” said Rene Albrecht, strategist at DZ Bank. Albrecht said the squeeze, a result of demand for bonds to use as collateral going into the typical thin year-end period, was more significant for German bonds given that the free float available for investors to buy is much lower than what is available in other markets. The 10-year yield, the benchmark for the euro area, was down 4 bps to -0.26%. Analysts saw the sharp widening in swap spreads this week as another sign of the collateral scarcity. For example, two and five-year swap spreads are at their widest since the start of the pandemic, in a sign of markets becoming risk averse. The collateral scarcity means that investors are likely expressing their positioning through the swaps market instead, analysts said. Elsewhere, Italy’s 10-year yield rose as much as 6 bps, rising above 1% for the first time in over a week, but was last unchanged at 0.96%. Focus was on Italian president Sergio Mattarella signalled he may not seek a second term as president, according to daily Corriere della Sera. “What market fears is that that implies perhaps that (Prime Minister Mario) Draghi is going to move aside and move to the presidential role,” said Gareth Hill, fund manager at Royal London Asset Management. (Reporting by Yoruk Bahceli; additional reporting by Stefano Rebaudo Editing by Mark Potter and Saikat Chatterjee)