April 27, 2017 / 10:18 AM / 3 months ago

UPDATE 1-Central bank economic optimism unnerves euro zone bond investors

4 Min Read

* ECB may talk of rosier economic outlook

* Could pave way for monetary tightening signals

* BOJ most optimistic about economy in nine years

* German states report solid inflation rates

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds quote, German data)

By John Geddie

LONDON, April 27 (Reuters) - Euro zone government bond yields nudged up on Thursday with the bloc's central bank expected to reiterate Japan's acknowledgment of better growth prospects in a move that could pave the way towards tighter monetary policy.

The European Central Bank's meeting on Thursday comes immediately after solid inflation data from the bloc's biggest economy and a Bank of Japan meeting overnight at which it offered its most optimistic economic assessment in nine years.

While the BOJ kept monetary policy unchanged, for the first time since 2008 it used the word "expansion" in describing the state of the economy, signalling that it sees no need for additional stimulus.

The ECB is also expected to keep its ultra-easy stance firmly in place but may talk of a rosier economic outlook, setting the stage for a small signal as early as June about an eventual reduction of stimulus.

That could involve interest rate hikes and a slow withdrawal of its asset purchase scheme, likely to precipitate a decline in the value of bonds and a rise in yields.

David Lloyd of British asset management firm M&G Investments said that his "conversations with central bank staffers" suggest the ECB is not concerned about market ructions that tightening policy would cause.

"Any sense of systemic risk, like the vulnerability of major financial institutions, they are all over that like a rash. But if we get a massive sell-off in the bond market and people lose money then they are entirely relaxed about that," said Lloyd, the firm's head of institutional portfolio management.

Benchmark German Bund yields -- which move inversely to prices -- climbed 2 basis points to 0.37 percent in early trades on Thursday, heading back towards 14-month highs of 0.51 percent seen in the wake of the ECB's last meeting, at which it signalled a diminishing urgency for policy action.

A number of German states on Monday reported a rise in year-on-year inflation, with some reporting rates in April above the ECB's near 2 percent euro zone-wide target. National data is due at 1200 GMT.

Language Change

Policymakers tried to downplay the ECB's eagerness to withdraw stimulus in the wake of the March meeting, while nerves around the French election and disappointing economic data have since reversed some of the yield rise and tempered rate hike expectations.

But Reuters reported this week that policymakers, relieved after the first round of France's presidential vote put a pro-euro centrist in pole position, may in June once again change the wording of the ECB's opening statement.

Any comments on Thursday about the bloc's improving economic prospects could be a nod to that, but some investors still feel policymakers will be reluctant to signal a major policy shift.

"The (ECB's) language around the 'downside risk to growth' may go, but anything too explicitly hawkish would be harmful for monetary policy transmission," said Mizuho strategist Peter Chatwell.

"I think we will hear that QE will be in place for a long time to come."

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

Additional reporting by Dhara Ranasinghe and Abhinav Ramnarayan; Editing by Catherine Evans; editing by John Stonestreet

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