March 2, 2017 / 11:38 AM / 9 months ago

UPDATE 2-Euro zone bonds on defensive as inflation hits 2 pct, US rate-hike talk grows

* Euro zone inflation hits 2 pct in Feb

* Bund yields at highest in just over a week

* Talk of March U.S. rate hike weighs on market

* French bonds outperform, spread vs German tightens

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

By Dhara Ranasinghe and John Geddie

LONDON, March 2 (Reuters) - Germany’s benchmark 10-year bond yield rose to its highest level in just over a week on Thursday after inflation in the bloc hit 2 percent for the first time in four years last month, shooting past the European Central Bank’s inflation target.

With the exception of France, bond yields across the euro area edged higher, buttressed by expectations that the U.S. Federal Reserve will raise interest rates later this month.

Inflation in the 19-member euro area rose to 2 percent last month, from 1.8 percent in January, increasing pressure on the ECB, which targets inflation of below but close to 2 percent, to end loose monetary policy.

Analysts said a pick-up in headline inflation had been expected after strong country data in recent days, limiting a bigger selloff in bond markets for now. German inflation soared to its highest level in four-and-a-half years in February, data on Wednesday showed.

Also, an underlying measure of euro zone inflation held steady at 0.9 percent last month, suggesting that once the oil price surge passes through the numbers, inflation will fall back.

Still, the overall pick-up in inflation does not bode well for bond markets and is seen fuelling talk of a scaling back in ECB stimulus.

The ECB is scheduled to run its quantitative easing bond-buying scheme until at least December and has pushed interest rates deep into negative territory to try to stimulate weak growth and hitherto stubbornly low inflation.

“Psychologically, 2 percent inflation could be important and there will be more pressure building on the ECB to taper, especially if the economy continues to grow,” said KBC strategist Piet Lammens.

The ECB is scheduled to meet next on March 9.

German 10-year bond yields rose 4 basis points to 0.32 percent, adding to Wednesday’s 4 bps rise seen after policymakers suggested the Fed was worried about waiting too long to raise rates in the face of looming economic stimulus from Washington.

U.S. two-year Treasury yields hit their highest level in more than 7-1/2 years on Thursday on increasing expectations of a Fed rate hike this month.

In contrast, sentiment towards battered French bonds improved further, narrowing the gap between 10-year yields in France and Germany to a fresh one-month low around 58 bps.

French presidential election frontrunner Emmanuel Macron on Thursday unveiled his manifesto, saying he would root out inequalities in France’s pension system, sell government stakes in major firms and downsize parliament.

Macron, a former investment banker running as an independent centrist, is favourite to win the unpredictable race in a May run-off against far-right leader Marine Le Pen.

“Any significant candidate, whether that’s Macron or (Francois) Fillon, that highlights they have a plan is likely to be viewed as positive by markets,” said Rabobank strategist Matt Cairns.

“This not only reduces the chance of a Le Pen victory but outlining a concrete plan for the economy defuses the market sensitivity to fragmentation risk in the euro zone that is implied by a Le Pen victory.”

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

Editing by Alison Williams

Our Standards:The Thomson Reuters Trust Principles.
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