January 4, 2019 / 11:32 AM / 6 months ago

UPDATE 1-German bond yields rise from 2-year lows after great start to 2019

* German Bund yield rise from over two-year lows

* Set for biggest weekly drop since Oct

* Euro zone flash inflation slows, core CPI stable

* US jobs data due out

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates with reaction to EZ inflation data)

By Dhara Ranasinghe

LONDON, Jan 4 (Reuters) - Long-dated German government bond yields rose from more than two-year lows on Friday as news of a new round of trade talks between the United States and China lifted sentiment in battered equity markets, denting demand for safe-haven bonds for now.

Data showing euro zone inflation slowed in December more than markets had forecast, but core indicators remained stable, also helped take the shine off the German bond market where yields have fallen sharply this week on global growth worries.

Euro zone inflation rose 1.6 percent in December on the year, slowing from 1.9 percent in November. But the core indicator — which excludes volatile energy and food prices and is watched closely by the European Central Bank — was stable at 1.1 percent in December, and in line with market expectations.

Germany’s benchmark 10-year bond yield hit a session high after the data, rising to 0.189 percent — up from more than two-year lows hit Thursday at 0.146 percent.

Across the bloc, most long-dated bond yields were 2-3 basis points higher on the day.

Even though core inflation held steady in December, weak economic data and a recent decline in oil prices suggested the outlook for euro zone inflation remained weak, analysts said.

“Fundamentally, the inflation numbers are not good and headline inflation has taken a step down because of oil and will take another step down,” said Chris Scicluna, head of economic research at Daiwa Capital Markets.

“Core inflation at (around) 1 percent is still well below where the ECB would like to see it before thinking about raising rates.”

A key long-term market gauge of euro zone inflation expectations, the five-year, five-year inflation breakeven forward, fell to 1.5317 percent on Friday — its lowest since mid-2017. It held close to those levels after the inflation data.

Euro zone interest rates will remain low as long as needed to bring inflation back to the central bank’s 2 percent target, ECB policymaker Benoit Coeure said on Friday.

In a sign of the pessimism gripping world markets at the start of a new year, two-year U.S. Treasury yields on Thursday fell below 2.4 percent to reach parity with the federal funds effective rate for the first time since 2008. That suggests investors doubt the U.S. central bank can continue to tighten monetary policy as its forecast implies.

German 10-year bond yields are down around 6 bps this week - set for their biggest weekly drop since October.

“Levels below 30 or 20 bps suggest a risk of a crisis or that we are already in crisis mode,” said DZ Bank rates strategist Daniel Lenz, referring to German Bund yields.

“Exaggerated or not, investors are concerned about the economic outlook given the trade disputes, worries about a U.S. shutdown, weak data and falling inflation expectations.”

In Italy, the bond market recovered some ground after a selloff on Thursday amid worries over struggling Italian lender Banca Carige .

Reporting by Dhara Ranasinghe, editing by Larry King and Martyn Herman

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