February 28, 2018 / 11:47 AM / 7 months ago

UPDATE 2-Euro zone bond yields dip as inflation slows

* Bond yields dip, partly reversing Tuesday’s sharp rise

* Euro zone consumer price growth slowed in February

* Gap between US and German borrowing costs widen

* Euro zone periphery government bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Fanny Potkin

LONDON, Feb 28 (Reuters) - Euro zone bond yields dropped across the board on Wednesday as inflation in the bloc slowed, potentially complicating the European Central Bank’s plan to remove monetary stimulus and move towards raising rates.

Annual consumer price inflation dropped as expected to 1.2 percent in February, capping a steady fall from 1.5 percent in November. The ECB wants to raise inflation to a target of below, but close to, 2 percent.

Core inflation, which strips out volatile energy and unprocessed food prices and is watched closely by the central bank, held stable at 1.2 percent.

The data, which followed subdued inflation numbers from Germany on Tuesday, brought relief to investors who have in recent weeks readied for a change in the ECB’s ultra-easy policy stance.

“With inflation dropping to 1.2 percent and core inflation stable at 1 percent, expectations of a quick return of inflation seem exaggerated for the euro zone, making a cautious ECB next week very likely,” ING senior economist Bert Colijn said in a note.

He was referring to another measure of core inflation that many market economists look at, which also excludes alcohol and tobacco.

Most euro zone government bond yields edged lower on the day.

The yield on Germany’s 10-year government bond, the benchmark for the bloc, was lower 2 basis points to 0.66 percent, well off the recent multi-year high of 0.81 percent. It is set for its first monthly fall since October, down 3 basis points.

France’s 10-year government bond yield fell 3 bps to 0.92 percent, well off the 1.05 percent level of the start of February.

Bond markets in Europe and the United States had taken a knock on Tuesday after U.S. Federal Reserve Chairman Jerome Powell said data since December pointed to a strengthening economy and his confidence had increased that inflation would rise.

The gap between benchmark German and U.S. 10-year government bond yield hit a peak of 223 bps overnight on Tuesday following Powell’s remarks, its highest since December 2016.

“The negative Fed talk has had little impact on bonds or euro area peripherals,” analysts at Societe Generale said in a note.

“So any surprises in the German and Italian votes this weekend could be amplified by the lack of much adjustment so far.”

Italy holds a national election this Sunday - the same day that Germany finds out the results of a ballot of Social Democrat party members on a coalition deal with Chancellor Angela Merkel’s conservatives.

Later on Wednesday, the U.S. publishes GDP numbers for the fourth quarter.

The German finance agency sold 2.413 billion euros in a top-up of its 10-year Bund on Wednesday with demand falling short of its 3 billion euros target.

Reporting by Fanny Potkin; graphic by Dhara Ranasinghe; Editing by Jon Boyle and John Stonestreet

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