July 16, 2018 / 10:54 AM / a year ago

UPDATE 2-Euro zone bond yields up after strong U.S. retail sales

* Strong U.S. data pushes up US, European bond yields

* German/US 2-year yield gap at widest in 30 years

* Focus on Powell speech as investors fret on tariff impact

* Italian short-term yields drop after Savona comments

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates with reaction to US retail sales)

By Dhara Ranasinghe and Abhinav Ramnarayan

LONDON, July 16 (Reuters) - Euro zone government bond yields rose across the board on Monday after strong U.S. data sparked a selloff in U.S. Treasuries.

U.S. retail sales rose 0.5 percent last month, while May data was revised higher, helping push two-year U.S. Treasury yields to 2.61 percent - their highest level since August 2008.

That pushed the gap over short-dated German bond yields, the euro zone’s benchmark, to a 30-year high at around 327 basis points.

This gap reflects a divergence between the rate outlook in the United States, where the Federal Reserve is raising borrowing costs, and the euro area where the European Central Bank has signalled that it will keep rates low for a considerable period.

Still, with U.S. Treasuries selling off, euro zone bond markets also fell out of favour with investors and in late afternoon trade, 10-year bond yields were up 2-4 basis points across the bloc.

“It’s mainly U.S. Treasury-led,” said Orlando Green, a fixed income strategist at Credit Agricole in London. “I’m surprised by the extent of the move, but I think markets were caught off guard a little.”

In Germany, 10-year bond yields were up 3 bps at 0.31 percent, off six-week lows hit on Friday.

Some investors are now treating a recently issued German August 2028 bond as the new 10-year benchmark; that bond was yielding 0.37 percent on Monday.

Earlier in the day, high-grade euro zone bond yields had hovered near recent lows as softening Chinese growth kept markets wary about the potential global economic impact of a trade dispute between the United States and other major countries.

China’s economy expanded at a slower pace in the second quarter as Beijing’s efforts to contain debt crimped activity, while June factory output growth weakened to a two-year low in a worrying sign for investment and exporters as a trade war with the U.S. intensified.

Investors were also closely monitoring news from a summit between U.S. President Donald Trump and his Russian counterpart Vladimir Putin in Helsinki, although their comments had little immediate impact on bond markets.

In Rome, EU Affairs Minister Paulo Savona was reported to have said Italy had proposed to the EU to be allowed to spend an extra 50 billion euros, which is approximately 2.7 percent of the country’s GDP.

“The news that Italy asks for more spending is not a surprise, but the tone from Savona was a lot more conciliatory, so that is reassuring,” said Mizuho strategist Antoine Bouvet.

Even as euro zone bond markets sold off in afternoon trade, short-dated Italian bond yields held lower.

On Friday, ratings agency DBRS confirmed Italy’s rating at BBB (High) and said that expected deviations from current fiscal targets were unlikely to materially undermine its public debt sustainability. (Reporting by Dhara Ranasinghe and Abhinav Ramnarayan; Additional reporting by Sujata Rao; editing by John Stonestreet)

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