March 10, 2017 / 9:37 AM / in 4 months

UPDATE 3-Euro zone bonds jolted by ECB rate hike discussion

4 Min Read

* Bund yields at 5-week high, 30-year highest in over a year

* Some ECB rate-setters raised possibility of hike - sources

* Money markets price in ECB rate hike by March 2018

* U.S. Feb non-farm payrolls jump 235,000 (Writes through)

By Dhara Ranasinghe and John Geddie

LONDON, March 10 (Reuters) - Euro zone bond yields soared on Friday after a report that some European Central Bank policymakers had discussed the possibility of rate hikes rattled markets already jolted by signs the ECB may be stepping back from its ultra-easy monetary policy stance.

Germany's benchmark 10-year Bund yield was set for its biggest fortnightly rise in nearly two years, while bond yields across the bloc were 6-10 basis points (bps) higher and money market futures fell - reflecting higher expectations for ECB rate rises in the future.

Sources told Reuters some ECB rate-setters had raised the possibility of hiking rates from their current record lows before the end of QE, but that the discussion was brief, and there was not broad support for the idea.

Still, the comments were enough to unsettle markets, coming a day after the ECB signalled a diminishing urgency for more policy action and highlighted an improving economic outlook. The euro jumped to a three-week high against the dollar on the report.

"The case for raising rates in the midst of a QE programme seems a weak one, but it has caused unease in the market," said Chris Scicluna, head of economic research at Daiwa. "It raises the question as to whether you can believe what the ECB said in its statement yesterday."

Investors now expect the ECB to raise interest rates by March 2018, according to money market pricing, while some banks are calling for multiple hikes next year.

Germany's 10-year bond yield - an indication of the rate at which a country can borrow on financial markets - climbed 7 basis points to a five-week high of 0.496 percent, within striking distance of a peak hit in January.

It has risen some 30 bps over the past two weeks, its biggest jump since June 2015.

Germany's 30-year bond yield rose to 1.29 percent , the highest since early 2016, while five-year yields were up 9 bps at minus 0.40 percent.

The gap between two- and 10-year German yields, meanwhile, topped 130 bps, its widest since June 2014. This so-called steepening of the yield curve indicates investor expectations for future inflation are rising.

Another key gauge of market expectations for long-term inflation in the euro zone - the five-year, five-year forward rate - rose to close to 1.73 percent and near its highest level for 16 months.

Amid a broad bond market rout on Friday, Italian and Spanish 10-year yields were set for their biggest weekly rise in four months. Spain's 10-year bond yield hit 1.89 percent, its highest since last June.

The prospect of an imminent rise in U.S. rates also weighed on bond market sentiment.

Data on Friday, showing U.S. job growth increased more than expected in February and wages rose steadily, could give the U.S. Federal Reserve the green light to raise rates when it meets next week.

Switzerland's 10-year government bond yield turned positive for the first time since September 2015 and the U.S. bond yield curve steepened, other signs that the tide may be turning for global bond markets.

"For years bonds have lived on soft growth, low inflation and unprecedented policy support," Societe Generale strategist Ciaran O'Hagan said.

"With the global economy now in firm recovery, central banks are gradually unplugging life support - a reality bond investors still cannot bear watching." (Editing by Mark Potter)

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