UPDATE 2-Euro zone bond yields drift sideways, off multi-month lows

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LONDON, Aug 13 (Reuters) – Euro zone government bond yields drifted sideways on Friday, with German borrowing costs holding above recent six-month lows in a sign that the rush to fixed income has abated for now.

After tumbling almost 26 basis points in July in the biggest monthly fall in almost two years as global reflation bets turned tail, Germany’s 10-year bond yield has edged higher this month.

An improving U.S. labour market and speculation the U.S Federal Reserve could soon start to unwind its bond buying stimulus have lifted U.S. and European bond yields.

In the euro area, however, an expectation the European Central Bank will keep its hefty asset purchase scheme in place for some time to support growth and help boost inflation continues to underpin bond markets.

So, European bonds have outperformed Treasuries, with the gap between 10-year yields in the United States and euro zone benchmark Germany widening to almost 183 basis points (bps) on Thursday, its widest since June.

“There has been a bit of a move higher (in yields) but Bund yields are still pretty close to the lows,” said Rabobank senior rates strategist Lyn Graham-Taylor.

“The euro area is lagging a bit in terms of the recovery and there is most likely an expectation that the rebound won’t be as strong as in the U.S.”

U.S. 10-year Treasury yields are up 16 bps from six-month lows hit last week; Germany’s Bund yield is up 6 bps from last week’s six-month low of -0.52%.

On Friday U.S. borrowing costs fell after consumer sentiment dropped sharply in early August, with the 10-year Treasury yield down 6 bps to 1.31%.

Bund yields were steady at around -0.46%. Most other 10-year bond yields were also broadly unchanged.

A key gauge of the market’s long-term euro zone inflation expectations, however, hit a fresh three-year high at around 1.715%.

Graham-Taylor said rising inflation expectations could most likely be explained by a view that supply bottlenecks caused by the COVID-19 outbreak would lift inflation in the short-term.

Analysts said the key driver for bond markets remained the outlook for tapering by the Federal Reserve, back in focus after stronger-than-expected jobs data a week ago.

A Reuters poll published on Friday showed a majority of economists expect the Fed to announce a plan to taper its asset purchases in September.

Fund managers at Janus Henderson Investors believe markets are likely to challenge the Fed’s view that a pick-up in inflation is transitory as the economy strengthens.

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