UPDATE 1-Euro zone bond yields rise ahead of U.S. inflation reading

(Adds details, updates prices)

Aug 11 (Reuters) – Euro zone bond yields rose on Wednesday, tracking U.S. Treasury yields higher ahead of crucial U.S. inflation data that is expected to set the tone for markets.

U.S. consumer prices are expected to have risen 5.3% year-on-year in July, according to a Reuters poll, slightly below last month’s 5.4% but keeping inflation elevated.

The data will follow comments by two U.S. Federal Reserve officials that inflation is already at levels that satisfy one leg of a key test for tightening policy.

Fed rate-setters’ comments alongside better-than-expected U.S. jobs data last Friday halted the sharp fall in yields seen in July and the start of August in both the U.S. and the euro area.

On Wednesday, Germany’s 10-year yield, the benchmark for the euro area, touched the highest since July 29 at -0.435% and was up one basis point by 1008 GMT to -0.44%, comfortably above six-month lows at -0.524% touched last week.

A market gauge of long-term euro zone inflation expectations rose above 1.69% for the first time since late 2018.

But while 10-year U.S. Treasury yields were up 3 bps on Wednesday and over 6 bps this week, German 10-year bonds have outperformed, as yields are up only 1 bp this week. Bond yields move inversely with prices.

“The relative Bund strength will be put to the test with another bumper (consumer price index) lining up and more hawkish Fed talk lingering,” Commerzbank strategists Michael Leister and Hauke Siemssen said.

The outperformance of German Bunds has further widened the gap between 10-year German and U.S. Treasury yields to 182 bps on Wednesday, the widest since June.

The diverging outlook of the European Central Bank from the Fed, especially after its revision of its inflation target will mean it keeps rates lower for longer, has supported euro area government bonds.

Inflation-adjusted “real” yields, often monitored as a gauge of expected financial conditions, have also risen from record lows in the euro area in recent sessions after driving July’s bond rally.

But their rise has also been less than in the U.S and they have fallen since the start of the week.

“We expect USD rates will rise much faster from here. With Fed tapering coming into view, the divergence with ECB (quantitative easing) policy will become more obvious,” ING analysts told clients.

Southern European bonds underperformed on Wednesday and Italian bond yields were 4 bps after rising to the highest since August 3 at 0.598%.

That pushed the closely watched gap with German 10-year yields to 103 bps after it fell below 100 bps for the first time since July 14.

In the primary market, Germany raised 3.316 billion euros from the re-opening of a 10-year bond at auction, the bloc’s only auction this week.

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