Bund yields hit 17-month high on prospects of less Fed stimulus
* Ten-year German yields hit highest since March 2012
* Markets expect minutes to show Fed may taper in September
* Debt risk premia rise across the euro zone
By Marius Zaharia
LONDON, Aug 19 (Reuters) - German 10-year bond yields hit their highest since March 2012 on Monday as investors bet the Federal Reserve would start scaling back monthly bond purchases as early as next month.
Traders said investors were positioning before Wednesday's release of the Fed's July meeting minutes, which could firm up expectations the central bank would move next month.
Anticipation the Fed would begin to "taper" its $85 billion a month bond-buying programme hit assets broadly. Debt premia over German benchmarks reversed some of their recent tightening, which was fuelled in part by data last week showing the euro zone emerged from a long recession in the second quarter.
"Everything is being offered, people seem willing to sell in any kind of strength," one trader said.
"The main story here is U.S. tapering. The only uncertainty is the timing, but that could become more clear on Wednesday. Not everybody is convinced (about September), myself included, but it's kind of hard to stay in the way of the sell-off."
German 10-year yields rose 2.8 basis points to 1.902 percent, having earlier hit their highest since March 2012 at 1.924 percent. Their U.S. counterparts hit fresh two-year highs of 2.875 percent.
Bund yields posted their biggest weekly rise since June last week on the Fed outlook and expectations of euro zone recovery. Investors will next gauge the state of the bloc's economy on Thursday, when PMI business surveys are due.
"If we see a further improvement in PMIs confirming the worst is over and the economy is bottoming out, the 2 percent level will become a possibility sooner rather than later," RIA Capital Markets strategist Nick Stamenkovic said.
Many analysts remained cautious about the euro zone economy and said market moves may have gone too far.
"You're getting to a point where you have to take a step back. Growth may have difficulties to continue to surprise," ICAP strategist Philip Tyson said
Bund futures dropped 34 ticks to 139.88, 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 widened on Monday to 239 and 253 bps, respectively. Italian bonds underperformed their euro zone peers, with outright 10-year yields rising 9 basis points to 4.29 percent.
Traders said that due to seasonally low volumes, domestic insurers began selling Italian bonds well in advance to make room in their books before a debt sale at the end of the month.
Volumes in the BTP future were about 20,000 lots, compared with a daily average of 33,000 for this year.
"Italy has had a great run, one of the reasons being the gap of supply, but that's ending next week," a second trader said.
Investors will also watch for signs of political tensions. Italian media said centre-right leader Silvio Berlusconi, convicted of tax fraud, would bring down the government in October if he is expelled from the Senate.
Italian stocks also fell, with traders citing the Berlusconi report as an excuse to take profit on a 14 percent rise in the main Milan index in the past month.
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