October 17, 2019 / 10:45 AM / a month ago

UPDATE 2-Euro zone bond sell-off cools as Brexit optimism kept in check

* Thursday bond sell-off reverses after doubts on Brexit deal

* Bund yields hold up at highest level since late July

* Analysts wait and see ahead of UK parliamentary vote

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates throughout, adds analyst comment)

By Elizabeth Howcroft, Tommy Wilkes and Yoruk Bahceli

LONDON, Oct 17 (Reuters) - A euro zone bond sell-off cooled on Thursday after optimism around a Brexit deal between Britain and the European Union came to a halt and eyes turned to a British parliament vote to approve the deal over the weekend.

After several days of negotiations, Prime Minister Boris Johnson said that Britain and the EU had agreed a “great” new Brexit deal. European Commission President Jean-Claude Juncker said an EU summit should endorse the agreement.

But Northern Ireland’s Democratic Unionist Party, which props up the minority Conservative Party government, reiterated that it could not support the proposed deal as it stood.

In an extraordinary Saturday sitting, the first since 1982, parliament will vote on approving Johnson’s deal. Britain is due to leave the EU on Oct. 31.

The EU side looked unfavourably at an extension beyond the Oct. 31 deadline as European Commission President Juncker said there must be no prolongation and Ireland’s finance minister said talking about an extension in the event of a rejection by parliament would be “profoundly unhelpful” .

“The market is very wary at this point in time as it is still very unclear if the deal will go through on Saturday,” said Nordea Asset Management strategist Sebastien Galy.

Germany’s 10-year government bond yield, which rose as much as 7 basis points to -0.33% on optimism around the deal earlier on Thursday, was down 1 bp on the day at -0.40%.

10-year yields are holding up at their highest level since late July.

UK government bonds outperformed on the uncertainty, with the 10-year yield down 3 basis points at 0.69%.

Yields fell after investors dumped euro zone government bonds in recent days, anticipating Britain and the EU can reach another agreement on Britain’s departure, avoiding more uncertainty that could damage both economies.

The 10-year bund yield had risen 6 basis points over the last two days.

“It was a bit of knee-jerk, the sell-off that we saw,” said Mizuho rates strategist Peter McCallum.

“The bond market’s just holding ground now and waiting to see what happens,” McCallum added.

A market gauge of long-term euro zone inflation expectations on Thursday rose as high as 1.235% - a near four-week high - given progress on one of the most pertinent sources of economic uncertainty facing the euro zone.

Pooja Kumra, European rates strategist at TD Securities, said she was cautious but that the “chances of a deal have increased massively since October”.

Reduced tensions between China and the United States over trade and some confidence that the euro zone economy is recovering have also encouraged many to sell bonds for riskier assets. Weaker-than-expected U.S. retail sales data on Tuesday did little to reverse the selloff.

That was in contrast to the summer, when jittery investors piled into euro zone debt on any sign of economic weakness and in anticipation of another round of European Central Bank monetary easing.

Editing by Larry King and Nick Macfie

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