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LONDON (Reuters) - Euro zone government bond yields rose on Tuesday as investors returning from holidays across the globe were welcomed by sharply rising oil prices and data showing that German inflation hit its highest level in more than three years in December.
German consumer prices, harmonised to compare with other European countries (HICP), were up by 1.7 percent on the year after an annual increase of 0.7 percent in November. [nL5N1ET1RT]
Earlier, December inflation in the bloc's second biggest economy, France, hit its highest rate since May 2014. [nP6N1BQ04O]
The likely underlying driver is a rebound in energy prices, but inflation is also expected to be bolstered in 2017 by the fiscal policies of U.S. President-elect Donald Trump and signs of faster growth in China.
Oil prices hit 18-month highs on Tuesday, bolstered by hopes of a deal between producers to cut output. [O/R]
"The main driver is the weaker currency (against the dollar) and a rise in commodities prices - that in itself is not a positive," said Mizuho strategist Peter Chatwell.
"But if it feeds through into wages, then it could lead to an increase in the economic output of the stronger euro zone countries, and yields could rise further from March onwards."
Long-term inflation expectations in the euro zone, measured by the five-year, five-year forward rate EUIL5YF5Y=R, rose to their highest level since December 2015 and close to the ECB's target of near 2 percent.
"Until just a few weeks ago, the general consensus was that upside inflation risks were very limited," said DZ Bank strategist Birgit Figge.
Overall euro zone numbers will be published on Wednesday, with economists expecting prices to have grown 1 percent year-on-year, up from 0.6 percent previously. ECONALLEZ
German 10-year bond yields, the euro zone benchmark, rose 10 basis points to a two-week high of 0.29 percent DE10YT=TWEB having hit a two-month low of 0.16 percent on Monday.
Most other euro zone equivalents were up 8-13 basis points, with France FR10YT=TWEB and Ireland's IE10YT=TWEB at well over two-week highs.
Portugal's 10-year benchmark bond yield rose as much as 23 bps to a high of 3.95 percent, the highest since Dec.12, when it hit a six-month high.
A private business survey indicated that China's factory activity had picked up more than expected in December as demand accelerated, with output reaching a near-six-year high. [MKTS/GLOB]
That came on the heels of data showing manufacturers in Europe had accelerated activity at the fastest pace in more than five years in December.
Later in the session, the dollar index .DXY rose to a new 14-year high after data showed U.S. manufacturing activity had grown more than expected. [nL1N1ET0KR]
In signs elsewhere that the growth and inflation outlook were growing more buoyant, Europe's blue-chip stock index added another 0.7 percent on Tuesday , having hit a one-year high on Monday.
For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets
Additional reporting by Abhinav Ramnarayan; Editing by Kevin Liffey