December 15, 2016 / 8:35 AM / 7 months ago

UPDATE 3-Euro zone bond yields rise as Fed signals more hikes

4 Min Read

(Updates prices)

By John Geddie

LONDON, Dec 15 (Reuters) - Euro zone government bond yields rose on Thursday after the U.S. Federal Reserve raised interest rates in the world's largest economy and signalled a faster pace of hikes in 2017.

The increase in the federal funds rate to a range of 0.50 to 0.75 percent late on Wednesday was widely expected. But the prospect of quicker monetary tightening contributed to a sell-off in U.S. Treasury yields and stocks.

U.S. Treasury yields climbed further when European trading opened on Thursday with 10-year yields at their highest in more than two years, stretching the gap with their German equivalents to its widest since early 1989, according to Datastream.

It was the Fed's first meeting since the election of Donald Trump to the U.S. presidency in November. Trump's promises of tax cuts, spending and deregulation have already prompted some policymakers to shift their view on the outlook for 2017.

Analysts said there could be further yield rises later on Thursday after the U.S. publishes November inflation data.

"The Fed delivered a more hawkish Fed hike this time around," Commerzbank strategist Rainer Guntermann said.

"While Bunds look set to stabilise this morning after the initial sharp sell-off, the yield highs ... should get tested again when U.S. inflation data adds to the reflation theme in the afternoon."

German 10-year bond yields rose 7 basis points to 0.37 percent, while U.S. equivalents added another 11 bps to Wednesday's 5 bps rise to their highest level since September 2014 at 2.64 percent, before easing to 2.61 percent by 1615 GMT.

The gap between U.S. and German 10-year yields stood at 224 basis points at 1615 GMT, while the gap between the respective two-year yields was the widest in more than 16 years at 206 bps.

"My expectations are for the German-U.S. Treasury spread to remain really wide," said Nick Gartside, chief investment officer for fixed income at JP Morgan Asset Management.

"It goes back to what the respective central banks are doing - the ECB will remain accommodative next year, while the Fed's statement was certainly hawkish."

Other euro zone 10-year yields rose sharply, with Spain and Italy's up 5-6 bps at 1.45 percent and 1.85 percent, respectively.

While it was two-year bond yields that bore the brunt of the sell-off in the United States, with yields rising to their highest since 2009, short-dated euro zone equivalents were tamed by the European Central Bank's ultra-easy policy stance.

Analysts said the introduction of new rules designed to avoid a squeeze in short-term lending markets was underpinning the shorter-dated bonds used as collateral in so-called repo markets.

German two-year bond yields were down 1 bps to hit a record low of minus 0.78 percent.

The gap between two-year and 30-year German yields was near its widest in more than two years, a curve steepening that usually indicates that investors expect higher inflation and interest rates in the future. (Additional reporting by Abhinav Ramnarayan; Editing by Hugh Lawson and David Goodman)

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