October 25, 2017 / 11:08 AM / a year ago

UPDATE 3-Euro zone bond yields rise on prospect of tighter policy

* German yields track US Treasury and Gilt yields higher

* ECB expected to announce gradual withdrawal of stimulus

* Ifo survey shows pickup in business confidence in October

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices for close, adds US data)

By Abhinav Ramnarayan

LONDON, Oct 25 (Reuters) - Euro zone government bond yields rose on Wednesday as the prospect of higher interest rates in Britain and the United States piled pressure on a market already bracing for the withdrawal of ECB stimulus.

Germany’s 10-year bond yield, the benchmark for the region, hit a close-to-three-week high of 0.49 percent, up a basis point on the day and 3 bps off the day’s lows. Most other euro zone bond yields reversed early falls and were broadly higher.

The move higher comes a day ahead of a European Central Bank meeting at which it is expected to signal a reduction in its bond-buying scheme as the bank gradually withdraws its post-crisis stimulus.

Speculation about who will become the next Federal Reserve chief and stronger-than-expected UK economic growth data added to upward pressure on bond yields.

“The key upcoming events are the ECB meeting and the new Fed chair, and we have had a decent Ifo as well,” said Rabobank strategist Lyn Graham-Taylor, referring to the Munich-based Ifo economic institute’s survey, which showed a rise in business confidence in October.

“Also, gilts have sold off more than everything else, so that may be adding to it as well,” he added.

U.S. Treasury yields hit a seven-month high of 2.475 percent on the prospect of U.S. President Donald Trump appointing a hawkish Federal Reserve chief. A strong U.S. durable goods report added to a selloff in U.S. bonds.

Britain’s 10-year gilt yield spiked 8 bps to 1.44 percent as Britain’s economy unexpectedly picked up speed in the three months to September, putting the Bank of England on track to raise rates next week for the first time a decade.

The rise in yields helped Germany’s debt agency generate strong demand for a 3 billion-euro sale of 10-year Bunds, an encouraging sign ahead of Thursday’s ECB meeting.

Politicians from four German parties seeking to form a coalition government agreed late on Tuesday to stick to the policy of a balanced budget, a document seen by Reuters showed.

The possibility of tax cuts and extra spending under a new government led investors to speculate there could be a fiscal boost for Europe’s largest economy, which in turn could have a similar effect on the bond market to “Trumpflation”.

“There’s room for manoeuvre even if they keep a balanced budget,” said DZ Bank strategist Andy Cossor.

Rising inflation expectations suggest that the ECB has reason to start withdrawing stimulus. A key gauge of euro zone inflation expectations hit a seven-month high.

Most analysts expect the ECB to trim asset purchases from 60 billion euros a month to 30 billion from January for nine months, following reports suggesting rate setters favour a “lower for longer” scenario.

Southern European government bonds, seen as most sensitive to any tightening of monetary policy, moved largely in pace with better-rated peers, suggesting the market is not expecting any significant shocks to the hawkish side.

Editing by Hugh Lawson and Andrew Roche

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