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UPDATE 2-Euro zone yields fall after ECB comments on rising borrowing costs

* ECB signals it is becoming uncomfortable with rising yields

* German borrowing costs set biggest daily fall since December

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts the lead, adds strategist comment, background)

LONDON, Feb 22 (Reuters) - Euro zone government bond yields fell on Monday after European Central Bank chief Christine Lagarde said the ECB was “closely monitoring” rising borrowing costs.

Borrowing costs across the single currency bloc rose sharply this month as prospects for more U.S. fiscal stimulus boosted hopes for a faster economic recovery globally.

Lagarde’s comments, the clearest sign yet that policymakers in Europe are becoming uncomfortable with the recent surge in yields, pushed yields back down.

“The ECB cannot afford any rise in nominal or real yields unless there is inflation because higher yields tighten the bloc’s economic conditions,” said Althea Spinozzi, fixed income strategist at Saxo Bank.

“The ECB will do anything to put European sovereign bond yields in check.”

Germany’s 10-year Bund yields fell 3.5 basis points to -0.34%, setting their biggest daily fall since mid-December. In the morning they hit a fresh eight-month high, after rising almost 12 bps last week, the biggest weekly jump since June.

U.S. Treasury yields were unchanged on Monday, ahead of remarks U.S. Federal Reserve chairman Jerome Powell is scheduled to give on Tuesday.

U.S. real yields rose around 20 bps last week in a sign that the selloff in Treasury markets was broadening out.

“This is a key change, since it questions the credibility of the Fed’s pledge to tolerate inflation overshooting in the future under its Average Inflation Targeting framework,” said AXA Group chief economist Gilles Moec.

“It is understandable why U.S. Treasury yields are rising and are expected to do so,” said Chris Scicluna, head of economic research at Daiwa Capital Markets.

“If you put U.S. fiscal stimulus together with the better trend in vaccinations and coronavirus, that does point to a stronger recovery and a step up in inflation in the U.S. and Europe even if temporary.”

A survey from Germany’s Ifo institute on Monday showed that German business morale rose by far more than expected in February, hitting its highest level since October.

In perhaps a more worrying sign for policy makers, real or inflation-adjusted bond yields have also risen sharply in the past week. Germany’s 10-year inflation-linked yield on Monday rose to -1.28%, its highest since last October.

Elsewhere, Italy’s 10-year bond yield was down 2.5 bps on the day at 0.60%.

A recent selloff has steepened the German yield curve, with the gap between 2- and 10-year bond yields at its widest in almost a year, at around 39 bps.

Reporting by Dhara Ranasinghe, additional reporting by Stefano Rebaudo, Editing by Nick Macfie

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