Bund yields hit 17-month high on euro zone recovery prospects, Fed
* Ten-year German yields hit highest since March 2012
* Markets positioning for strong PMI readings this week
* Italian, Spanish debt risk premia stay near 2-year lows
By Marius Zaharia
LONDON, Aug 19 (Reuters) - German 10-year government bond yields hit their highest since March 2012 on Monday as investors bet the euro zone's economic recovery will stay on track and the Federal Reserve soon scale back its monetary stimulus.
The bloc's economy crawled out of a long recession in the second quarter, data showed last week, while surveys pointed to an improved outlook, fuelling the biggest weekly rise in Bund yields since June.
The rise in yields has been also driven by the recovery in the United States, where the Federal Reserve is widely expected to slow the pace of its monthly bond purchases as early as next month. Minutes of the Fed's July meeting are due on Wednesday and will be scrutinised for any hints on the timing.
German 10-year yields rose 0.5 basis points to 1.88 percent, having hit their highest since March 2012 at 1.924 percent at the open. Their U.S. counterparts hit fresh two-year highs of 2.871 percent.
"There's an expectation activity generally, not only in the United States, is better than it was a while ago," ICAP strategist Philip Tyson said. "But with U.S. yields at two-year highs you're getting to a point where you have to take a step back. Growth may have difficulties to continue to surprise."
Bayerische Landesbank chief strategist Marius Daheim expected Bund yields to test 2 percent near-term, but doubted the sell-off in German debt could continue for much longer.
"It's going to be a bumpy road (for the economy)," he said.
Investors' next opportunity to gauge the state of the euro zone economy will come on Thursday, when PMI business surveys are due. Analysts said the rise in yields suggested the market was positioning for another set of strong data.
"However we think the PMIs are more likely to disappoint, possibly offering support to Bunds later in the week," Commerzbank rate strategist Rainer Guntermann said in a note.
Bund futures dropped 6 ticks to 140.16, having earlier hit a 10-month low of 139.71.
Recovery bets have supported bonds of the euro zone's lower-rated states, where growth is crucial to shrink public debt, pushing the yield premia offered by Italian and Spanish 10-year bonds over German Bunds to two-year lows last week.
However, the spreads were slightly wider on Monday, at 238 and 252 bps, respectively.
Credit Agricole strategists said the fact that no peripheral debt auctions are scheduled until the end of the month and expectations of low domestic market volatility should push Italy's debt risk premium below 215 bps in the near term.
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