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UPDATE 3-Euro zone yields continue to climb after German election

·3 min read

(Updates prices)

By Dhara Ranasinghe

LONDON, Sept 27 (Reuters) - Euro zone 10-year bond yields rose to their highest in almost three months on Monday as a brief decline after Germany's election gave way to concerns that major central banks could tighten monetary policy sooner rather than later.

German bond yields initially fell as the risk of a leftist coalition taking shape after Sunday's election faded. However, the focus quickly returned to the prospect of central banks taking away hefty post-pandemic stimulus as economies recover.

Germany's Bund yield rose to roughly three-month peaks at -0.19%, reversing early falls to -0.24%.

By 1510 GMT, however, bund yields were up just up 1 basis point on the day at -0.216%.

"We don't know much yet about the make up of the next German government but we do know that a left-coalition is off the table and that's been reassuring for markets although the reaction was brief," said ING senior rates strategist Antoine Bouvet.

The centre-left Social Democrats (SPD) of Finance Minister Olaf Scholz won 25.7% of the vote, ahead of 24.1% for Chancellor Angela Merkel's CDU/CSU conservative bloc.

To secure a majority in parliament, the SPD may seek an alliance with the Greens and the liberal Free Democrats (FDP) in a "traffic light" coalition. The two parties could also team up with the conservatives in a so-called Jamaica coalition.

While coalition talks could drag on for weeks, investors took comfort from the fact that the election results suggest the next government would be made up of largely centrist parties with analysts anticipating more fiscal stimulus.

"The SPD has held the finance department for a while and a lot of Germans have put a lot of confidence in Scholz and understand that fiscal policy can be used for good," said Anatoli Annenkov, senior European economist at Societe Generale.

"So the question is whether that will still hold and if it does that would be good for both Germany and Europe."

European bond yields were broadly higher. Italy's 10-year bond yield briefly rose to 0.83%, its highest in almost three months. At 1514 GMT it was up 1.5 basis points at 0.7979%.

U.S. 10-year Treasury yields touched 1.5% for the first time since June before pulling back to 1.48%.

Analysts cited stickier than expected inflation as a reason for rising yields.

"This is a reaction to the fact that many market participants had been too relaxed on the inflation signs, they haven't anticipated the Fed starting tapering in November," said Hans-Jörg Naumer, senior investment strategist at Allianz Global Investors.

The Federal Reserve said last week it would likely begin reducing its monthly bond purchases as soon as November.

European Central Bank President Christine Lagarde, meanwhile, told a European parliament committee that inflation could exceed the ECB's raised projections, but there were few signs of this already happening.

Elsewhere, the EU sold a five-year bond at auction.

(Reporting by Dhara Ranasinghe; additional reporting by Julien Ponthus; Editing by Alison Williams, Alex Richardson and David Clarke)