January 7, 2020 / 11:27 AM / 16 days ago

UPDATE 2-Euro zone bond yields up from three-week lows as Mideast fears abate

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Dhara Ranasinghe

LONDON, Jan 7 (Reuters) - Euro zone government bond yields edged up from around three-week lows on Tuesday as market fears of an all-out conflict between the United States and Iran abated, easing demand for safe-haven assets for now.

Oil prices also gave up some of their gains as investors reassessed Middle East risks after a U.S. air strike killed a top Iranian commander on Friday.

“The knee-jerk reaction to the air strike, with equities sliding and bonds rallying, has petered out, as so far there is no follow-through, although the situation remains dire,” said Christoph Rieger, rates strategist at Commerzbank.

Most 10-year euro zone bond yields were steady to marginally higher but above lows hit on Monday. Germany’s benchmark Bund yield was little changed around -0.28% — rising from more than three-week lows on Monday at -0.31% but below last week’s seven-month highs.

Data showing euro zone inflation accelerated last month had been widely expected after German and French inflation data exceeded forecasts last week.

Eurostat said consumer prices in the euro zone rose 1.3% year-on-year in December, up from 1.0% in November. That matched the forecasts of economists polled by Reuters.

A narrower measure that excludes food, energy, alcohol and tobacco prices was steady at 1.3% year-on-year.

“The move lower in yields is hard to justify with data starting to look up,” said Antoine Bouvet, a senior rates strategist at ING. “Overall, for the market, the rise in core inflation takes it to historically high levels.”

Analysts say they are closely watching inflation and inflation expectations, which fell last year, especially if Middle East tension keeps oil prices high for a prolonged period.

Oil prices that rise 30% or more above their December average of $65 per barrel, for three months or longer, would make a major difference to its forecasts for growth and inflation, analysts at Berenberg said.

The five-year, five-year break-even inflation forward, an inflation gauge, edged up after Tuesday’s flash inflation data to around 1.32%.

Elsewhere, Slovenia sold a new 10-year bond via a syndicate of banks and Ireland said it would sell a new 15-year government bond through syndication.

Spanish lawmakers are expected to vote by the narrowest of margins on Tuesday to confirm Socialist leader Pedro Sanchez as head of a left-wing coalition government, ending political gridlock.

Spain’s 10-year bond yield was around 2 bps higher on the day at 0.41%. Analysts said the latest political developments had been priced into markets and they were more focused on Italian political risks.

Better-than-expected U.S. non-manufacturing sector and factory orders data also put a floor under bond yields.

Reporting by Dhara Ranasinghe; Editing by Larry King and Lisa Shumaker

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