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UPDATE 2-Euro zone bond sell-off deepens on ECB exit bets
June 28, 2017 / 7:28 AM / 2 months ago

UPDATE 2-Euro zone bond sell-off deepens on ECB exit bets

* Key inflation gauge hits highest in a week

* Bets firm on stimulus reduction in September

* Sell-off in Europe spills over to U.S. Treasuries

* Benchmark German yield nearly doubles in two days (Adds quote, updates prices)

By John Geddie

LONDON, June 28 (Reuters) - Euro zone bond yields rose sharply for a second straight day on Wednesday as the European Central Bank reignited expectations for future inflation and a possible reduction of its stimulus as soon as September.

Yields have risen sharply since ECB President Mario Draghi opened the door on Tuesday to tweaks in the bank's aggressive monetary stimulus policy, with short-dated German yields hitting a one-year high.

The sell-off was even more pronounced in longer-dated bonds as investors started to price in a higher path for price growth.

Germany's 10-year yield has nearly doubled in two days. It jumped 10 basis points from 0.24 percent to 0.34 percent on Tuesday to strike a one-month high, and then a further 6 bps on Wednesday to 0.40 percent.

Draghi stressed on Tuesday that any change in the bank's stance, which includes sub-zero rates and a massive quantitative easing (QE) bond-buying scheme, should be gradual as "considerable" support was still needed and the inflation rebound would also depend on favourable global financing conditions.

But the tone of his speech, which for some analysts appeared to jar with a cautious posture at the central bank's meeting earlier this month, has led to a reassessment of how soon the ECB may start to withdraw its support.

"Mario Draghi did the number one thing that he wanted to avoid, market disruption. Are we looking at Europe's taper tantrum?," Cantor Fitzgerald strategist Ryan McGrath said, referring to the sharp rise in U.S. Treasury yields after the U.S. central bank hinted at reducing QE in 2013.

"The hawkish remarks were well tempered... However, investors choose not to see them... Draghi started prepping the market for the next substantial instalment of forward guidance (that we are expecting in September) where QE tapering will be announced."

Draghi's comments coincided with a government report in Germany - the harshest critic of the ECB's easy stance - which showed that low interest rates posed the biggest threat to the country's financial system.

Other benchmark 10-year bond yields in the euro zone rose to multi-week highs, the euro hit a one-year high against the U.S. dollar, and a key market gauge of long-term inflation expectations in the bloc hit a three-week high.

In another sign that inflation bets were building, Germany's yield curve -- the gap between short- and long-dated borrowing costs -- was its steepest in around two weeks.

The sharp move in Europe spilled over to the United States, even though a delay to a U.S. healthcare reform bill was further evidence of the difficulties President Donald Trump may face pushing through his growth-boosting spending plans.

U.S two-year yields hit a 3-1/2-month high on Wednesday with 10-year yields at a one-month peak. (Reporting by John Geddie; Editing by Helen Reid, Andrew Heavens and Pritha Sarkar)

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