3 Min Read
* ECB chief was overinterpreted by markets - sources
* Euro zone yields pull back from highs
* Markets hanging on central bank talk
* BOE's Carney says to debate rate hike in coming months (Updates throughout)
By Dhara Ranasinghe, John Geddie and Abhinav Ramnarayan
LONDON, June 28 (Reuters) - German short-dated bond yields pulled back from one-year highs on Wednesday after central bank sources smoothed over comments from ECB chief Mario Draghi that investors had interpreted as signalling a policy tightening was imminent.
The comments from Draghi on Tuesday, viewed as hawkish following his cautious tone at this month's European Central Bank meeting, had sent government bond yields and the euro sharply higher.
He said deflationary forces had been replaced by inflationary ones, but any policy change should be gradual as considerable monetary support was still needed.
The sell-off in bonds, sensitive to any signs that the ECB may be getting closer to unwinding the massive stimulus that has pinned down borrowing costs, continued into Wednesday but abated after ECB sources said Draghi's comments had been over interpreted.
"At the moment markets are singing to the tune of central bankers," said Orlando Green, European fixed income strategist at Credit Agricole.
"The balance the ECB is trying to strike is removing policy accommodation slowly but surely and at the same time not allowing the market to get ahead of itself in pricing in rate hikes."
German two-year government bond yields dipped 1.5 basis points to minus 0.58 percent, retreating from a one-year peak of minus 0.53 percent hit earlier in the day.
Germany's benchmark 10-year Bund yield was up 2.5 basis points on the day at 0.38 percent, but off one-month highs hit earlier in the session at around 0.41 percent.
French 10-year bond yields also pulled back from a one-month high at around 0.78 percent, while Spanish and Portuguese bond yields were 3-4 basis points lower on the day .
The euro fell after the ECB sources-based report but recovered, hitting a one-year high of $1.1390 after weaker-than expected U.S. pending home sales data.
The pan-European STOXX 600 briefly turned positive on the report, and was trading flat after languishing in the red since the open.
"The market is looking for any read on the timing of tapering and maybe overinterpreted Draghi's speech," said Rabobank strategist Lyn Graham-Taylor. "When I read his speech yesterday I thought the reaction was quite a violent one given what was actually said."
Adding to a second day of volatile trading, Bank of England Governor Mark Carney said a UK interest rate rise was probably necessary and the bank would debate this "in the coming months."
British gilt yields jumped on the comments, putting some upward pressure on their euro zone peers. (Reporting by London Markets team; editing by John Stonestreet)