German bond yields hit 2-1/2-year high after U.S inflation data

By Fanny Potkin and Abhinav Ramnarayan

LONDON (Reuters) - German government bond yields hit their highest level in more than two years and European stocks fell briefly on Wednesday, after data showing U.S. inflation rose more than expected in January fanned expectations for higher U.S. interest rates this year.

Consumer prices in the world's largest economy overshot forecasts and a measure of underlying inflation posted its biggest gain in a year, strengthening expectations of a faster pace of interest rate increases from the Federal Reserve.

"U.S. Treasury yields briefly hit their highest level in over a year as the market grappled with the latest inflation numbers, which came in much higher than consensus had predicted," said Craig Inches, head of short rates and cash at Royal London Asset Management.

"This sell-off fed through into global government bond markets, with gilt and Bund yields also spiking."

The yield on Germany's 10-year government bond , the benchmark for the region, reversed earlier declines and rose around 3 basis points to 0.774 percent - its highest level since September 2015, according to Tradeweb data.

Most euro zone bond yields were up 1 to 3 bps on the day as U.S. Treasury yields rose in the wake of the data.

The 5-year, 5-year breakeven forward, a European Central Bank barometer of market long-term inflation expectations in the euro zone, rose to a one-week high above 1.76 percent .

An index of European stocks volatility <.V2TX> jumped on the release but fell back shortly afterwards and was still lower on the day. The S&P 500 volatility index <.VIX> briefly turned positive, then moved back down and was last trading at 24.67.

European stocks <.STOXX> fell briefly after the data before moving back into positive territory. The pan-European index was last up 0.5 percent. Bank stocks <.SX7P> reduced their gains to trade up just 0.1 percent on the day.

Elsewhere, Greece's five-year bond yield rose 10 bps to 3.879 percent, its highest since early December. Ten-year yields rose to a two-month high of 4.49 percent.

Portugal's bond market outperformed, with 10-year yields trading at 1.94 percent, down 3.5 bps on the day after dipping as low as 1.911 pct.

The country sold 1.25 billion euros of five-year and 10-year bonds in an auction earlier in Wednesday after data showed its economy grew at its fastest pace in 17 years.

Southern European government bonds were in demand earlier on Wednesday, outpacing better-rated peers as data showed growth in the bloc was the highest in a decade in 2017.

(Additional reporting by Helen Reid & Dhara Ranasinghe, editing by Larry King)

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