April 23, 2018 / 11:25 AM / a year ago

UPDATE 2-Euro zone bonds sell off as US 10-year yield heads towards 3 percent

* Italy-German bond yield gap tightest in almost 2 years

* Italy appoints mediator to sound out chances of 5-Star/PD gov

* U.S.-German bond yield spread hits widest in 29 years

* Oil prices are squeezing investors out of government bonds

* Easing North Korea tensions lessen safety bid for bonds

* Treasury yields hove in on 3 pct, euro zone yields up 2-4 bps

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds Italian politics details, updates prices)

By Abhinav Ramnarayan

LONDON, April 23 (Reuters) - Investors sold euro zone government bonds on Monday after 10-year U.S. Treasury yields headed towards the psychologically significant 3-percent mark as rising commodity prices forced inflation expectations higher.

Signs of a thawing of relations between the United States and China, and North Korea’s decision to suspend nuclear tests are taking the edge off the flight-to-safety impulse and therefore also putting upward pressure on yields, analysts said.

The yield on 10-year U.S. Treasuries was within a shade of 3 percent, hitting 2.998 percent in European trade, and the spread over the German equivalent was briefly at its widest level in 29 years.

Analysts and investors say that should Treasury yields push past 3 percent, that would signal the start of a bear mearket for bonds and produce levels which have triggered market spasms in the past.

As the session wore on, many euro zone government bond yields began to match the rise in U.S. borrowing costs, and were up 2-4.5 basis points (bps) across the board.

German 10-year yields rose their highest in six weeks at around 0.638 percent.

Apart from the fact that the sovereign bonds from the world’s major economies tend to track one another as investors switch between them, Europe potentially faces the same inflation pressures as the United States from commodities prices.

“Every time you go to the gas station the price is higher - Brent crude is now close to $75 (a barrel) and that has had a knock on effect on government bonds,” DZ Bank analyst Rene Albrecht said.

Brent crude hit $74.15 a barrel on Monday, having hit its highest level since December 2014 the week before at $74.75.

“With pressure from oil, and also aluminium and steel prices, the inflation topic has made a kind of comeback after being derailed by the trade dispute headlines,” Albrecht said.

A market gauge of long-term euro zone inflation expectations, the five-year five-year forward swap , last Thursday hit its highest level since mid-March at 1.697 percent.

The U.S. equivalent on Monday hit its highest since November 2014.

“Inflation in the U.S. is more sensitive to oil prices than many other regions so it makes sense for inflation expectations to rise there,” Mizuho strategist Antoine Bouvet said.

“Also to an extent the sell-off has to do with geopolitical tensions seeming to have eased a little,” he said.

North Korea said on Saturday it would immediately suspend nuclear and missile tests, scrap its nuclear test site and instead pursue economic growth and peace, ahead of planned summits with South Korea and the United States.

There were also signs that relations between the world’s two largest economies may improve, after U.S. Treasury Secretary Steven Mnuchin said on Saturday he is considering a trip to China to work on trade issues.

Elsewhere, Italy’s 10-year government bond yield spread over Germany moved to its tightest levels in two years at about 115 bps, after Italy’s president asked the head of the lower house of parliament to sound out the possibility of the 5-Star Movement forming a government with the centre-left Democratic Party. (Reporting by Abhinav Ramnarayan, additional reporting by Fanny Potkin, Editing by Louise Ireland, William Maclean)

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