December 7, 2018 / 9:28 AM / 5 days ago

Core euro zone bond yields up, partially retracing steep decline

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Virginia Furness

LONDON, Dec 7 (Reuters) - German government and other high-grade euro zone bond yields rose on Friday, responding to a late rally on Wall Street overnight to retrace some of Thursday’s fall, the biggest in over two months.

German 10-year government bond yields rose nearly two basis points in early trade, following a five basis point fall on Thursday. The move comes ahead of a vote among Germany’s Christian Democrats on who replaces Chancellor Angela Merkel as party leader.

Other high-grade euro zone sovereign bond yields rose between one and two basis points .

Attention now turns to November U.S. employment data later on Friday, offering investors a temporary diversion from the brewing U.S.-China trade war, which sent stocks into a tailspin this week and sparked widespread demand for safe-haven bonds.

A strong report could allay fears about the U.S. economy’s health, seal the deal for an interest rate hike later this month, and increase the probability that the Federal Reserve will raise rates more than once again next year.

“The most important number is how wages perform,” said Daniel Lenz, rates strategist at DZ Bank.

Financial markets are pricing in one rate hike from the Fed in 2019, compared with expectations for possibly two rate hikes a month earlier, according to CME Group’s FedWatch program.

U.S. Treasuries rallied strongly this week, with U.S. 10-year yields falling to three-month lows as traders scaled back expectations on the number of rate hikes the Federal Reserve might be able to deliver amid weakening economic data and trade conflict.

Renewed confidence in the U.S. economy and expectations that the Fed will continue raising rates will put upward pressure on core euro zone bond yields, especially with the European Central Bank preparing to formally end its 2.6 trillion euro bond-buying programme later this month and perhaps pave the way for rate hikes of its own later next year.

ITALY EYES KEY VOTE

Italian government bond yields fell by four basis points in early trade, again retracing some of the previous day’s sell-off, which saw yields rise by more than 10 basis points, the biggest rise since late October.

The Italy/Germany bond yield spread was last at 291.8 basis points, having widened nearly 20 basis points on Thursday. Italy’s 10-year government bond yield was four basis points lower on Friday at 3.16 percent.

Markets appeared relatively calm ahead of a possible confidence vote in parliament, where the ruling coalition has a large majority, to help accelerate the passage of the 2019 budget.

However, Deputy Prime Minister Luigi di Maio had to deny that his party had called on Economy Minister Giovanni Tria to resign.

The Italian government on Thursday bought back two BTP and three CCTEU bonds worth 3.2 billion euros while swapping investors into new bonds maturing October 2021 in a bid to manage its debt stock. (Reporting by Virginia Furness; Editing by Kevin Liffey)

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