May 4, 2018 / 11:06 AM / 2 months ago

UPDATE 1-Inflation divergence drives German/U.S. yield gap near 3-decade high

* Germany/U.S. spreads near widest since 1989

* U.S. payroll data should offer inflation clues

* Report quotes 5-Star Movement head repeating election call

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds China comments on trade dispute, updates prices)

By Abhinav Ramnarayan

LONDON, May 4 (Reuters) - The difference between German and U.S. government bond yields was close to its highest in nearly three decades on Friday ahead of the release of U.S. jobs data that could further demonstrate the countries’ different inflation paths.

The short-dated and long-dated “transatlantic spread” between U.S. Treasuries and German Bunds were at 305 and 240 basis points respectively, just a shade away from their highest levels since early 1989 hit earlier in the week.

And they could go even wider, depending on the U.S. payroll data to be released at 1330 GMT, said one analyst.

“There will be a close look to average hourly earnings in the U.S. jobs report today for any guidance regarding future inflation,” said DZ Bank analyst Rene Albrecht.

“The next mark we could see is 250 bps (on the 10-year transatlantic spread) if we get different inflation dynamics in the U.S. and Europe,” he said, though he added that the spread should tighten in the long term with the United States so close to full employment.

Mizuho strategist Antoine Bouvet said that in addition, the U.S. Federal Reserve’s signal that it can tolerate higher inflation should also put some downward pressure on U.S. Treasury yields.

“If they are moving from being ahead of the curve to a more balanced approach, there isn’t much to prevent U.S. Treasuries from rallying further,” he said.

The dollar meanwhile, is set for its third consecutive week of gains against a basket of currencies and is up 3.6 percent in the last two weeks against the euro.

Euro zone inflation has been staying stubbornly low despite the ECB throwing a 2.55 trillion euro kitchen sink at it.

Inflation in the bloc, at 1.2 percent, fell short of expectations in the first quarter of the year, while the figure after stripping out the effects of energy, processed food, alcohol and tobacco was even more dramatically low at 0.7 percent.

U.S. consumer prices, on the other hand, accelerated in the year to March towards the Federal Reserve’s 2 percent target.

This means that the Fed should go ahead with rate hikes this year while prospects for a European Central Bank rate rise keep getting pushed further down the line.

Euro zone bond yields dropped on Thursday after that inflation data came out, and though most high-rated euro zone debt was flat to a touch higher on Friday, German 10-year borrowing costs were set for a second straight weekly fall.

At 0.53 percent, it is now well off its yearly peak of 0.81 percent hit in February.

A market gauge of long-term inflation expectations, the five-year forward swap, was back below the 1.70 percent mark, trading at 1.6911 percent on Friday morning.

Meanwhile, Italian 10-year yields held steady in the face of political volatility.

The leader of Italy’s anti-establishment 5-Star Movement dismissed proposals for a stop-gap government to reform the electoral law and repeated his call for a snap election in June, according to a newspaper interview on Friday.

Elsewhere, China and the United States have reached a consensus on some areas of their trade dispute but still have relatively big disagreements on others, China’s official Xinhua news agency said in a microblog post on Friday. (Reporting by Abhinav Ramnarayan Editing by Mark Heinrich)

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