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UPDATE 2-Germany's two-year yield hits 2008 high after UK economic plans

·2 min read

(Recasts, adds comments)

By Yoruk Bahceli and Stefano Rebaudo

Sept 23 (Reuters) - Germany's 2-year government bond yield reached the highest since 2008 on Friday as economic plans revealed by the British government led to jumps in gilt yields and dragged on wider euro zone bond prices.

British short-dated yields jumped almost 50 basis points (bps) as finance minister Kwasi Kwarteng announced tax cuts and household support measures that will see Britain borrow an additional 72 billion pounds.

An earlier yield jump in the euro area subsided during the session as analysts reckoned that market overreacted.

Germany's two-year yield was up as much as 15 bps on the day, rising above 2% for the first time since late 2008, before declining to 1.913% by 1521 GMT.

The market on Friday ramped up where rates are seen peaking to around 3.1% in late 2023, compared with around 2.7% a week ago.

“This is aggressive to say the least,” said Antoine Bouvet, senior rates strategist at ING, referring to the repricing of market expectations for the European Central Bank's rate hikes.

“The first step for the ECB is to go back to neutral which is probably around 2% at the moment,” he added. “Some hikes above that are possible but they become less likely as the euro zone enters a recession.”

Germany's 10-year bond yield, the benchmark for the euro area, rose 5 bps to 2.027%, after hitting its highest since 2011 at 2.113%.

"Today's rise in yields started with gilts. Some correlation between UK and euro zone bond prices is still in place," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

Bond yields rose more after a Reuters report said the ECB was seeking to change the terms of its TLTRO loans to reduce the payout to banks.

The rise in German yields follows big jumps earlier this week on the back of rising expectations for ECB rate hikes.

Germany's two-year yields, more sensitive to interest rate expectations, ended the week 35 bps higher, the biggest weekly rise since March.

Earlier on Friday, euro zone bond yields had fallen sharply after S&P Global's flash composite Purchasing Managers' Index for Germany, which tracks both manufacturing and services activity, fell to 45.9 in September from 46.9 in August and came in below a consensus of 46.0, while the services reading came in even further below the consensus.

The focus was also on Italy, ahead of elections on Sunday, expected to be won by a right-wing alliance.

Italian 10-year yields jumped 14 bps to 4.318% after hitting its highest since 2013 at 4.367%, while the closely-watched spread to Germany widened to 230 bps, having neared the lowest since mid-August earlier. (Reporting by Yoruk Bahceli and Stefano Rebaudo; Editing by Edmund Klamann, Frank Jack Daniel and Jonathan Oatis)