February 1, 2018 / 10:54 AM / 16 days ago

UPDATE 3-Euro zone yields rise as U.S. policymakers talk up inflation

* Euro zone yields up 2-3 bps on day

* Germany’s 10-year bond yield hits two-year high

* Strong results for French and Spanish auctions

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

By Fanny Potkin

LONDON, Feb 1 (Reuters) - German 10-year bond yields hit two-year highs on Thursday as yields firmed across the euro zone after policymakers in the United States flagged a potential uptick in inflation in the world’s biggest economy.

The U.S. Federal Reserve kept interest rates unchanged at its policy meeting on Wednesday but said inflation is likely to climb this year, bolstering expectations that borrowing costs will continue rising under incoming central bank chief Jerome Powell.

This pushed U.S. Treasury yields higher, followed on Thursday by euro zone counterparts that had already been at multi-year highs on expectations of tighter policy in Europe.

“Long-ended U.S. yields are still rising and that’s spilling over on the European market and Bunds especially. Ten-year Bunds are now taking more steer from U.S. developments than the domestic economy,” said Commerzbank rates strategist Rainer Guntermann.

Germany’s 10-year government bond yield, the benchmark for the euro zone, hit a two-year high of 0.738 percent..

French 10-year borrowing costs hit 1 percent for the first time since March 2017, Reuters data shows.

Ten-year U.S Treasury yields rose again on Thursday, holding near four-year highs hit in the previous session at about 2.75 percent.

“There is now the expectation of three or four rate hikes this year (in the United States) on the back of a bullish and strong economy in the U.S. and Europe,” said DZ Bank strategist Daniel Lenz.

“And, of course, with the ECB likely coming up with new forward guidance in the next meeting, the market is anticipating this as well.”

Borrowing costs across the bloc rose by 2-3 basis points, with new issuance by France and Spain well absorbed by markets, though peripheral bond yields continued to fall.

Spanish, Italian and Portuguese bond yields have benefited from the stronger growth backdrop and confidence that the euro zone’s lower-rated states will be able to withstand the withdrawal of monetary stimulus.

The euro zone’s booming manufacturing industry raced into 2018, churning out goods last month at a rate that was among the fastest in more than 20 years, a survey showed on Thursday.

With euro zone inflation still weak the European Central Bank needs to keep its stimulus measures in place, ECB Chief Economist Peter Praet said on Thursday.

The gap between Spanish 10-year bonds and German peers was at 68 bps, its tightest since April 2010, while the Italian/German yield spread was its narrowest since September 2016 at about 124 bps.

France, meanwhile, sold 8.8 billion euros in long and ultra-long bonds and Spain sold 4.05 billion euros of debt.

Reporting by Fanny Potkin; Additional reporting by Dhara Ranasinghe; Editing by Catherine Evans and David Goodman

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