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Euro zone yields rise as investors adjust to the Fed's hawkish tone

Kitco News

* Euro zone periphery govt bond yields (Adds ECB speakers, U.S. treasuries,)

LONDON, June 21 (Reuters) - Euro zone government bond yields rose along with U.S. treasuries on Monday as investors sought to adjust to the U.S. Federal Reserve's hawkish shift last week while long-term inflation expectations in Europe hit their lowest in three months.

The Fed surprised some investors last week by anticipating two rate hikes in 2023, which prompted U.S. Treasury yields to rise and global markets to turn risk-averse.

St. Louis Fed President James Bullard fuelled the market sell-off on Friday by saying that it was natural for the Fed to have "tilted a little bit more hawkish here to contain inflationary pressures."

After having hit a high of 1.59% on Wednesday, U.S. 10-year yields fell back to 1.36% on Sunday night before rising back to 1.49% around 0900 GMT on Monday.

Germany's 10-year Bund yield followed a similar pattern and stood at -0.17% at 1450 GMT, up about 3 basis points on the day.

Spain, Italy and France's 10-year yields were also slightly higher. .

There was little reaction in afternoon trading after European Central Bank President Christine Lagarde told European lawmakers that while the pandemic still weighed on the bloc's economy, growth could still rebound quicker than expected.

Lagarde added that it was not yet time to allow interest rates to rise, so the ECB would maintain favourable financing conditions.

Earlier, Governing Council member Mario Centeno said the recent rise in inflation in the euro zone and the United States is temporary and unlikely to have permanent effects.

This means the ECB should be able to maintain its current asset purchase programme until March 2022 and liquidity support measures are expected to be in place "at least until June 2022", Centeno told a banking conference in Lisbon.

Data released by the ECB showed the central bank bought a net 28.559 billion euros ($24.00 billion) of assets last week as part of its quantitative easing programme, above the 13.553 billion euros it purchased a week earlier.

A gauge of long-term inflation expectations - the five-year, five-year inflation forward - fell to its lowest since March, at 1.4887%.

The gauge had hit its highest since 2018 in May as investors had bet that a combination of central bank stimulus and an economic rebound from the COVID-19 pandemic would cause higher inflation - the so-called "reflation trade".

"It looks like there's been a broader reassessment by investors of the whole reflation trade," said Antoine Bouvet, senior rates strategist at ING.

"(If) we have a Fed that instead is reacting early then it makes sense that long-term inflation expectations drop."

"If the Fed acts early, they kind of open the way for other central banks to act early as well."

ING's Bouvet said that he expects the German Bund yield to dip in the short term as markets may still seek safer assets due to concern about rising COVID-19 cases.

Spain hired a syndicate of banks on Monday to sell a new 10-year bond, according to memos from two lead managers seen by Reuters.

The bond, due Oct. 31 2031 will be launched "in the near future subject to market conditions", according to the memos, a phrase debt management offices usually use a day before a sale.

Investors this week will also focus on the Bank of England's monetary policy meeting on Thursday and the release of euro area flash PMI data on Friday. (Reporting by Elizabeth Howcroft; additional reporting by Julien Ponthus; Editing by Ana Nicolaci da Costa, Chizu Nomiyama and Andrea Ricci)

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