* Banks scale back forecasts for lower German yields
* Bund yield seen ending 2016 higher than earlier estimates
* Sign that bond yields may be bottoming out
* Sentiment towards bonds turning negative
* Graphic: German 10-year bond yield forecast tmsnrt.rs/2ek8K0q
By Dhara Ranasinghe
LONDON, Oct 19 (Reuters) - Some banks are scaling back forecasts for deeply negative German bond yields that they issued after Britain’s decision to leave the European Union, as investors reassess the outlook for inflation and central bank policy, suggesting yields may have bottomed out.
The new forecasts for slightly higher yields than previously predicted partly reflects a growing expectation that the European Central Bank will remove a self-imposed floor for its bond-buying scheme later this year. That would make more bonds eligible and reduce demand for those now covered by the scheme.
German 10-year bond yields, the benchmark for euro zone borrowing costs, have risen about 15 basis points this month on a sell-off in British gilts, higher oil prices, growing expectations for a year-end rise in U.S. interest rates and jitters that the ECB may one day wind down quantitative easing.
A key market gauge of long-term euro zone inflation expectations has rebounded from record lows to 1.44 percent -- still below the ECB’s inflation target of just below 2 percent, but its highest level since early June.
Germany’s Bund yield is at 0.02 percent, up from a record low of minus 0.20 percent in July, when fears about the fallout from Britain’s decision to quit the EU boosted demand for safe-haven German debt.
But with bond yields globally on the rise, a number of banks have changed their forecasts in recent days, in perhaps another sign that a 35-year bull run in government bond markets is petering out.
Rabobank, which after the Brexit vote forecast Bund yields would fall low as minus 0.3 percent, now expects them to end 2016 at 0.1 percent, up from a previous estimate of zero percent.
“We’ve had clients say to us we’re out on a limb now as everyone else becomes more bearish on bonds,” said Richard McGuire, head of rates strategy at Rabobank. “We’re still bullish long-term, as the outlook for global growth remains fragile, but there are a number of headwinds right now.”
Both Mizuho and DZ Bank forecast 10-year German yields to end the year around zero percent, up from previous estimates that put them in negative territory.
Societe Generale, which changed its forecasts in late September, sees Bund yields ending the year at minus 0.10 percent from a previous estimate of minus 0.25 percent, grinding higher next year.
In a note released after the June 23 Brexit referendum, SocGen put the range for German Bund yields at minus 0.25 percent to minus 0.45 percent.
The median forecast by analysts polled by Reuters in September is for Bund yields to end the year at zero percent. reuters://realtime/verb=Open/url=cpurl://apps.cp./Apps/mm-bondyield-polls?s=AL&st=G
Steven Major, global head of rates strategy at HSBC, who correctly called the steep fall in global bond yields in recent years, said this month that yields will remain at current historical lows for another five years.
For some analysts, a reason to forecast slightly higher yields is a view that the ECB will remove the deposit-floor rule for its asset-purchase programme when it announces tweaks to the scheme later this year.
Removing the self-imposed rule that the ECB can only buy government bonds with a yield below the bank’s deposit rate would increase the pool of eligible bonds for QE and reduce downward pressure on yields. Speculation about such a move has also started to move money market rates.
“We were not previously pricing in the ECB buying bonds below the deposit rate,” said Peter Chatwell, head of European rates strategy, at Japanese bank Mizuho.
“The chances of that have increased and that means we have to look at the shape of the yield curve, which would steepen,” he said, adding that Bund yield could rise to 0.2 percent over the next month. (Reporting by Dhara Ranasinghe, editing by Larry King)