October 17, 2016 / 10:41 AM / in 10 months

UPDATE 2-Bund yields bump above 0.1 pct as ECB countdown begins

* German 10-year yields highest since June

* Thursday's ECB meeting in focus

* Market seeks clarity on potential tweaks to ECB bond-buying

* Scope for "tapering" also in focus (Updates prices for close)

By Dhara Ranasinghe

LONDON, Oct 17 (Reuters) - German 10-year bond yields topped 0.1 percent on Monday for the first time since the results of the Brexit referendum in June, pushed higher by rising U.S. and British yields as investors turned their focus to this week's European Central Bank meeting.

The ECB may discuss technical changes that would allow it to extend its 1.7 trillion-euro ($1.90 trillion) of asset purchases beyond the March 2017 end-date, at a time when talk of a potential "taper" of its scheme has put markets on edge.

Bond yields have risen since the ECB last met in September, with more now falling within the bank's eligibility criteria. That creates some space for the ECB, which faces a scarcity of bonds eligible for quantitative easing.

Germany's 10-year bond yield, for instance, is up 21 basis points this month, moving out of negative territory to top 0.1 percent on Monday, its highest since the results of Britain's referendum on European Union membership on June 24.

Even the yield on its six-year government bond briefly nudged above minus 0.40 percent -- the cut-off for ECB purchases -- for the first time since June.

A suggestion by Federal Reserve Chair Janet Yellen on Friday that the central bank may allow inflation to exceed its 2 percent target pushed U.S. bond yields to four-month highs.

Meanwhile, a recent plunge in the pound has sparked inflation worries that drove 10-year Gilt yields to their highest level since the Brexit vote.

TAPER

Commerzbank estimates that the ECB will run out of eligible German sovereign and agency paper to buy by next summer, pushing back that deadline from last month when yields were lower.

Analysts expect the ECB to keep policy unchanged this week and wait until December to announce a possible extension and tweaks to the programme.

Still, the ECB's news conference with President Mario Draghi will be scrutinized as investors assess both the scope for further easing and eventual tapering.

"Rhetoric will be very important this week," said Martin Van Vliet, senior rates strategist at ING. "Draghi will try to play down the taper talk and may give some hints on what to expect in December."

Most economists do not expect the ECB to start scaling back its massive monetary stimulus soon, but note that a report this month that the ECB might reduce or 'taper' the scale of its purchases before the scheme finally ends has struck a chord.

Market pricing suggests a 10 bps rate cut is priced in by the end of 2017.

INFLATION KEY

Against this backdrop economic data could play a more important role in shaping market expectations for what the ECB will do next.

"We think the ECB will declare victory once it becomes more and more certain that inflation is moving above 1 percent and then it will start to prepare markets for tapering," said Shweta Singh, a senior economist at Lombard Street Research.

Data on Monday confirmed euro zone inflation in September at 0.4 percent, well below the ECB's target of just under 2 percent. It is expected to rise in coming months on higher oil prices.

A key market gauge of long-term inflation expectations has started to move higher. The five-year, five-year breakeven forward, which measures where the market expects 2026 inflation forecasts to be in 2021, is trading around 1.42 percent -- its highest level since June.

But euro zone bond markets are not expected to witness a "taper tantrum" on the same scale as that in U.S. bond markets after former Federal Reserve Chairmen Ben Bernanke suggested in 2013 that U.S. quantitative easing would be slowly wound down.

The experience of that sell-off, which saw U.S. Treasury yields jump just over 100 bps between May 2013 and early 2014, could weigh on the ECB's mind.

UBS estimates that long-dated yields on core euro zone government bonds will rise by around 70 bps by the time QE is fully tapered.

"With tapering likely to start next year, you will continue to see bond-buying throughout 2017," said Mark Dowding, co-head of investment grade, BlueBay Asset Management.

"In this environment, German Bunds are going to remain scarce and that will limit how high yields can rise in a material fashion." (Editing by Catherine Evans)

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