December 27, 2017 / 12:01 PM / 6 months ago

UPDATE 1-Short-dated German yields rise as U.S. curve flattens further

* Schatz yields hit highest since Oct. 2 at minus 0.668 bps

* Most 10-year euro zone yields edge 1-2 bps lower

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (updates prices, adds in Italian auction)

By Abhinav Ramnarayan

LONDON, Dec 27 (Reuters) - Short-dated German government bond yields hit a 2-1/2 month high on Wednesday, tracking market developments across the Atlantic after equivalent U.S. Treasury yields rose overnight to their highest levels since 2008.

The U.S. Treasury curve has been flattening all year as investors price in rising benchmark interest rates against a backdrop of subdued inflation. The same trend is visible in Europe, where an eventual withdrawal of stimulus by the ECB is being anticipated.

“I think we are seeing some flattening in the Bund yield curve driven by the U.S. and some anticipation of an (ECB) rate hike maybe in mid-2019,” said DZ Bank strategist Christian Lenk.

“Either way, investors are starting to believe that we won’t see minus 75 basis points again (on the Schatz yield), so why not grab some profits here as yields normalise to some degree.”

Earlier this month, the ECB raised its growth forecasts for the euro zone from this year through to 2019 and nudged up its expectations for inflation to 1.7 percent, closer to its target of just below 2 percent.

The Schatz yield rose two basis points to minus 0.668 percent on Wednesday, the highest level for German two-year debt since Oct. 2, according to Tradeweb data.

The gap between German 2-year and 10-year yields narrowed to 108 basis points.

While still deep in negative territory, the Schatz yield has risen significantly since early 2017, when it dipped as low as minus 0.96 percent. It was pushed to those levels as the ECB concentrated its bond-buying scheme around short-dated bonds.

French two-year bonds were up 2 basis points at minus 0.514 pct, close to their highest level since July.

Yields on most high-grade euro zone bonds in the 10-year part of the curve settled lower on Wednesday as a risk-off sentiment pervaded the market following last week’s election victory for secessionist parties in Catalonia.

The Spanish region’s deposed separatist leader Carles Puigdemont last weekend called on the Madrid government to allow him to return home from self-imposed exile in Brussels for the opening session of the Catalan parliament so that he can become its next president.

Most euro zone bond yields were 0-1 bps lower with Germany’s 10-year government bond yield, the benchmark for the region, dropping to 0.41 percent.

But Italian 10-year yields gained 4 basis points to 1.9 percent, near two-months highs. Italy plans to auction up to 7 billion euros of debt over four bonds on Thursday.

Reporting by Abhinav Ramnarayan & Fanny Potkin; editing by John Stonestreet

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