December 1, 2016 / 9:05 AM / in a year

Euro zone yields higher as oil-price surge lifts inflation expectations

LONDON, Dec 1 (Reuters) - Germany led euro zone government bond yields higher on Thursday as the first output cut by major oil producers since 2008 triggered a surge in oil prices and boosted expectations of higher inflation.

Italian government bonds stabilised with investors reluctant to push prices much lower before this Sunday’s referendum on constitutional changes.

Bond sales in France and Spain later in the day were expected to provide a gauge of sentiment ahead of the vote.

But for now, a deal by the Organization of the Petroleum Exporting Countries (OPEC) and Russia to reduce output to drain a global supply glut grabbed the market’s attention.

Germany benchmark 10-year Bund yields rose 3 basis points to a one-week high around 0.30 percent, while 30-year bond yields rose to a 2-1/2 week high at around 0.98 percent .

A market measure of euro zone inflation expectations, the five-year, five-year breakeven forward, headed back towards recent 10-month highs above 1.63 percent.

“You can look at many countries and see that inflation is now on the rise and perhaps the risks to the outlook, given the OPEC deal, have shifted notably,” said Chris Scicluna, head of research at Daiwa. “Although how the deal will be implemented has to be treated with scepticism.”

The news, which sent oil prices to six-week highs, comes at a time when markets are reassessing the outlook for inflation and growth given the expansionary economic policies of U.S. President-elect Donald Trump and signs of stronger growth globally.

Steven Mnuchin, Trump’s nominee to run the Treasury Department, said on Wednesday tax reform and trade pact overhauls would be top priorities as they seek a sustained pace of 3 percent to 4 percent economic growth.

Further signs of stronger economic growth added to upward pressure on bond yields. Spanish factory output grew in November at its fastest pace since January, while Italian manufacturing activity grew in November at its fastest rate since June, surveys showed on Thursday.

In contrast to the rest of the region, southern European bond yields were only marginally higher, with Italian 10-year bond yields holding below 2 percent.

Analysts said that with a ‘No’ vote in Sunday’s referendum on constitutional change now largely priced into markets, there was a reluctance to push Italian yields much higher for now. Prime Minister Matteo Renzi has staked his future on a yes vote, but opinion polls have been pointing in the other direction.

A report this week that the European Central Bank is ready to step up purchases of Italian government bonds temporarily if the referendum result sharply drives up borrowing costs has also helped stabilise the bond market.

“A lot is priced into Italian bonds and even if there is a ‘No’ vote, especially with the ECB meeting next week, it is difficult to say how much BTPs will sell off,” said Orlando Green, European fixed income strategist at Credit Agricole.

For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url= (Reporting by Dhara Ranasinghe; Editing by Andrew Heavens)

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