German yields hit new 1-1/2 highs on euro zone, Fed outlooks
* Prospect of reduced US stimulus keeps up selling pressure
* German, UK GDP add to signs of improving global growth
* Uncertainty over how ECB will react to rising yields
By Marius Zaharia
LONDON, Aug 23 (Reuters) - German government bond yields hit new 1-1/2 year highs on Friday as an improved economic outlook and prospects of reduced U.S. monetary stimulus maintained selling pressure on low-risk debt.
Data confirmed that Germany's economy saw solid second-quarter growth, while the UK economy expanded more than initially thought.
Purchasing managers' surveys (PMIs) on Thursday showed business activity in the euro zone picked up this month faster than expected, raising expectations the third quarter will show further improvement.
"Data this morning is reinforcing the view economies are picking up. The bias is for core yields to move up," said Alan McQuaid, chief economist at Merrion Stockbrokers in Dublin.
German 10-year yields rose 4 basis points to 1.962 percent, their highest since March 2012. German Bund futures fell 47 ticks to 139.26, their lowest since September 2012.
One key question for investors is how the European Central Bank will react to the rise in yields, especially since it is 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. Some analysts warn tighter market conditions could drag on the recovery.
Jan von Gerich, chief strategist for developed markets at Nordea in Helsinki, said the ECB can do very little about it.
"The (ECB) Governing Council remains divided. If they couldn't garner support to cut rates earlier, they surely can't do that now," von Gerich said, adding the ECB will probably attempt "verbal intervention" to talk down short-term rates.
The ECB's Ewald Nowotny said he saw no reason for interest rate cuts, contrasting with remarks earlier this month from Executive Board member Peter Praet, who stressed the bank's "easing bias".
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 3 basis points higher at 0.26 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."
Other euro zone bonds were stable.
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