Euro zone and Fed outlooks keep German yields near 1-1/2 yr high

LONDON Fri Aug 23, 2013 3:32am EDT

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LONDON Aug 23 (Reuters) - German government bond yields rose on Friday, hovering around 1-1/2 year highs as an improved economic outlook and prospects of reduced U.S. monetary stimulus maintained selling pressure on low-risk debt.

Purchasing managers' surveys ({PMIs) on Thursday showed business activity in the euro zone picked up this month faster than expected, raising expectations third-quarter economic growth could show improvement over the forecast-beating second-quarter data.

Data on Friday confirmed that Germany's economy saw solid second-quarter growth of 0.7 percent on the quarter.

Yields could not break new ground at the open, however.

Some analysts even expected investors to buy back into the cheapened Bund later in the day and take some time to reconsider whether the tighter market conditions could eventually slow down the recovery that is pushing yields higher.

German 10-year yields were 1 basis point lower at 1.93 percent, having risen to 1.943 percent on Thursday, the highest since Mach 2012. German Bund futures were 10 ticks down at 139.63.

"Markets were somewhat impressed with the (PMI) data, but not greatly so," said Jan von Gerich, chief strategist for developed markets at Nordea in Helsinki.

"I've seen bigger reactions to such data. This means further improvement in the economy is in the prices already, you need even more positive surprises to sustain the rise in yields."

Another question is how the European Central Bank will react to the rise in yields, especially since it not entirely driven by a recovering economy. Part of it is fuelled by developments in the United States, where the Federal Reserve is expected to slow down asset purchases next month.

Money market rates have risen to levels last seen in June, just before the ECB took the unprecedented step of promising to keep rates low for a long time.

German Finance Minister Wolfgang Schaeuble said in a newspaper interview on Friday that the ECB has made clear it will raise interest rates again once the euro zone economy improves and that he welcomed that prospect.

German two-year yields were last 2 basis points higher at 0.25 percent, closer to the June highs of 0.33 percent than the July lows of 0.7 percent.

"Given the still shaky ground of the recovery in peripheral economies ... we expect the ECB will ultimately act to strengthen the forward guidance, capping Schatz yields and allowing the curve to steepen a lot further," Credit Agricole rate strategist Peter Chatwell said in a note.

"However ... as things stand with forward guidance relatively ineffective we think Schatz are rich, so until the ECB acts we think the Schatz can tend towards 0.34 percent."

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