* German 10-year yield up 10 bps this week
* French bond yields set for biggest weekly rise in two years
* Underlying U.S. inflation surprises on upside
* Strong euro zone industrial data adds to selloff
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices to close)
By Abhinav Ramnarayan
LONDON, July 12 (Reuters) - Safe-haven German government bonds were set for their biggest weekly selloff in nearly 1-1/2 years on Friday as signs of economic strength in Europe and the United States suggested fears of a downturn may be overdone.
Euro zone industrial production increased by 0.9% in May from the previous month, data from the European Union statistics agency Eurostat showed on Friday, comfortably beating expectations of around 0.2%.
That followed data on Thursday showing U.S. underlying consumer prices increased by the most in nearly 1-1/2 years in June amid solid gains in a range of goods and services.
“It was some much-needed good news as the data since (ECB President) Mario Draghi’s dovish speech in Sintra has largely disappointed,” said ING economist Bert Colijn, referring to Draghi’s June 18 comments.
“Still, industrial production is a very volatile indicator and after the poor April data, industry also needs to have grown at a decent pace in June in order for a contraction to be averted over the whole of the second quarter.”
German 10-year bond yields hit a 3-1/2 week high of minus 0.224%, before pulling back to around minus 0.25% in late trade.
Bund yields were nevertheless up 10 bps on the week and set for the biggest weekly rise since February last year — a sharp contrast to the hefty yield falls of recent weeks.
Other euro zone bond yields were 2-4 basis points higher on the day. French 10-year government bond yields were up 3 bps at 0.05%, set for its biggest weekly rise in over two years, up 13 bps.
Euro zone policymaker Benoit Coeure’s comments on Thursday have also contributed to this shift in euro zone government bond prices, said DZ Bank analyst Andy Cossor.
The ECB should take the low inflation expectations implied by bond prices with a pinch of salt as other gauges show greater confidence in the outlook, Coeure said on Thursday.
“Coeure’s speech yesterday indicated the ECB is ready to take action but not yet committed to changing forward guidance, deposit rate and revival of the QE programme — they need more evidence to do all three,” said Cossor.
A key market gauge of long-term euro zone inflation expectations, the five-year, five-year forward breakeven rate, rose on Friday to a three-week high at 1.28%. German annual inflation accelerated to 1.5% in June, moving closer to the ECB’s target, final data from the Federal Statistics Office showed on Thursday.
Reporting by Abhinav Ramnarayan; Editing by Toby Chopra and Catherine Evans