April 20, 2018 / 8:43 AM / 7 months ago

German bond yields set for biggest weekly rise since early Feb after oil surge

* German 10-year yield set for biggest weekly rise since Feb

* Long-term inflation expectations highest since mid-March

* BoE’s Carney dampens May rate hike expectations in UK

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

By Abhinav Ramnarayan

LONDON, April 20 (Reuters) - German government bond yields were set for their biggest weekly rise since the beginning of February after a surge in oil prices forced inflation expectations and euro zone bond yields higher.

Euro zone bond yields hit fresh highs on Friday and are now well above their levels at the start of the week after a sharp sell off prompted by Brent crude prices hitting a three-year-plus high of $74.75 a barrel on Thursday.

Higher oil prices tend to push up inflation, which in turn strengthens the case for tighter monetary policy and higher rates.

The yield on Germany’s 10-year government bond, the benchmark for the region, hit a near five-week high of 0.606 percent and is 9 bps higher this week so far, after having fallen in seven of the last 10 weeks.

French and Dutch equivalents were also set for their biggest weekly rises in ten.

“The market is hoping that higher oil prices will lead to higher inflation in a sustainable manner,” said DZ Bank strategist Sebastian Fellechner.

“But this is hard to say because oil prices are only one factor, we need confirmation, we need to see other factors kick in such as wage growth,” he added.

Still, a market gauge of long-term euro zone inflation expectations, the five-year five-year forward inflation-linked swap, closed Thursday at 1.67 percent, the highest level since mid-March.

The sell off in bonds this week comes after a long stretch in which euro zone yields were kept compressed by factors including the possibility of a trade war between the United States and other major world economies, China in particular.

As G20 policy meetings get underway, this will likely be a major topic for discussion ahead of next week’s European Central Bank meeting, Commerzbank analysts said in a note.

Already Japan has warned its G20 counterparts that protectionism and exchange of retaliatory measures will disrupt financial markets and heighten volatility.

The rise in euro zone bond yields comes despite a sharp fall in British borrowing costs after Bank of England Governor Mark Carney dampened May rate hike expectations in the UK.

The yield on 10-year Gilts dropped 4 bps while 2-year Gilts were as much as 5 bps lower on the day.

Later on Friday, Moody’s is set to review Portugal’s rating, and market participants are looking to see if the Iberian country regains its third major investment grade rating. (Reporting by Abhinav Ramnarayan; Editing by Toby Chopra)

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