March 16, 2017 / 9:28 AM / 4 months ago

UPDATE 3-Euro zone bonds U-turn as focus turns from politics to rate outlook

4 Min Read

* Bond yields rise as ECB comes back into frame

* Safe-haven bonds dented after Dutch election test

* France sells over 8 billion euros of bonds, pushing yields up

* Fed displays caution despite delivering first hike of 2017

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds quote, move in UK yields)

By Abhinav Ramnarayan and Dhara Ranasinghe

LONDON, March 16 (Reuters) - Euro zone government bond yields rose on Thursday, reversing early falls, as a reduction in political risks following a Dutch election allowed investors to look ahead to the potential implications for monetary policy.

Heavy supply also weighed on bond prices, pushing yields up. France sold over 8 billion euros of nominal bonds while Spain sold 4.8 billion euros of debt.

Most euro zone bond yields fell in early trade and the French yield spread over German benchmarks narrowed sharply as weaker-than-expected results for populist Geert Wilders in Wednesday's Dutch election eased concerns about a victory for the far right in French presidential elections in April and May.

However, the spread widened back to where it started, partly because French bonds were caught up in a broader sell-off in euro zone government bonds.

Focus also snapped back to other factors - not least expectations that the European Central Bank will move away from its ultra-loose monetary policy stance if political hurdles are navigated successfully.

"If these elections go by without any shocks, it means the potential next step for the ECB is likely to be less stimulus rather than more because as (ECB President Mario) Draghi has acknowledged, the European economy has been strong," said Gilles Pradère, senior fixed income manager at RAM Active Investments.

Euro zone government bond yields were up 4-7 basis points higher on the day, while the spread between French and German government bond yields was a touch wider on the day at 64 basis points.

Volatile Trade

Earlier, the French/Germany yield spread hit its narrowest in two weeks after results overnight showed Dutch centre-right Prime Minister Mark Rutte's VVD party taking 33 seats in the parliamentary election to 20 for Wilders' PVV.

In another day of volatile trade, Germany's 10-year Bund yield was up 4 bps at 0.45 percent, having fallen as low as 0.36 percent earlier.

"At the end of the day, we are seeing a risk-on move in global markets," said Philip Shaw, chief economist at Investec.

French government bonds were seen as vulnerable if the PVV had emerged as the biggest party, with French far-right leader Marine Le Pen expected to make it to a final round run-off.

The latest opinion poll suggests Le Pen will win the first round with 26.5 percent of the vote but centrist Emmanuel Macron is seen winning the second round comfortably.

The upward move in bond yields also came after the U.S. Federal Reserve delivered its first rate hike of the year on Wednesday, albeit having prepared the market well in the days before.

However, U.S. policymakers did not flag any plan to accelerate the pace of monetary tightening, prompting some analysts to brand it a "dovish hike".

Markets are pricing in two more rate hikes this year and three in 2018, analysts said.

There was also some pressure from selling in the UK bond market following a Bank of England meeting.

British 10-year gilt yields hit a one-month high at 1.29 percent following news that a BoE England policy maker unexpectedly voted to raise rates.

Editing by Alison Williams

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