April 25, 2018 / 10:30 AM / a month ago

UPDATE 2-Euro zone bonds feel the heat as T-bond yields push beyond 3 pct

* U.S. 10-year bond yields at 4-year highs above 3 pct

* Euro bond yields edge up but ECB caution caps rise

* Italian-German bond yield spread tightens further

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

By Dhara Ranasinghe

LONDON, April 25 (Reuters) - A rise in U.S. 10-year Treasury yields above 3 percent kept upward pressure on euro zone borrowing costs on Wednesday, although a looming European Central Bank meeting contained the sell-off in the single currency bloc.

The U.S. 10-year yield pushed further past 3 percent in European trade, having hurdled the psychologically important level on Tuesday as strong U.S. data reinforced the view that a 30-year bull market for bonds is nearing an end.

Rising benchmark Treasury yields, used as a global yardstick for interest rates on everything from home loans to corporate bonds, dragged European equivalents higher once more.

But analysts said they expected any selling in the euro zone to be limited a day ahead of the ECB meeting.

Germany’s benchmark 10-year bond yield briefly tested Tuesday’s six-week peak at 0.655 percent before pulling back to about 0.63 percent. Other euro zone bond yields were 0.5-1.5 basis points (bps) higher on the day.

British gilt yields meanwhile rose to their highest since early March.

“If U.S. 10-year yields continue to rise, this will have a cascading effect but at this stage we think 3 percent is a maximum yield,” ABN AMRO senior fixed income strategist Fouad Mehadi said.

“The (euro zone bond) market will be driven by ECB communication on its QE (quantitative easing) programme.”

The ECB is not expected to make any significant changes to its outlook on Thursday but its comments will be followed closely for further guidance on the timing of a scaling-back of massive monetary stimulus.

In particular focus is what ECB chief Mario Draghi has to say about a recent softening in economic data, which has prompted investors to push back expectations for a rate rise further into 2019.

Money-market pricing suggests that investors expect the ECB to deliver its first hike in this economic cycle by June 2019, having pushed back expectations from early next year. tmsnrt.rs/2HKfMx2

“The main focus will be on the weakness in the euro zone data in the early part of the year,” JPMorgan Asset Management fixed income portfolio manager Seamus Mac Gorain said.

“But there is no clear reason for the ECB to change the message.”

Italian bonds continued their outperformance on hopes of progress to end the political deadlock following last month’s election.

Italy’s anti-establishment 5-Star Movement has opened the door to coalition talks with the centre-left Democratic Party.

The Italian/German 10-year bond yield gap tightened further to about 112 bps - the narrowest in two years, before easing to 114 bps. The gap between Italian and Spanish bonds was at 47 bps and close to its tightest levels since January.

Reporting by Dhara Ranasinghe Editing by Louise Ireland

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