Euro zone bond yields higher on risk sentiment, flash PMIs

By Dhara Ranasinghe

LONDON (Reuters) - Euro zone bond yields rose on Monday as world stocks rebounded from last week's sell off and a closely watched gauge of business activity suggested that the bloc's economy is holding up well and price pressures are rising.

IHS Markit's euro zone Flash Composite Purchasing Managers' Index, seen as a good guide to economic health, fell to 59.5 in August from 60.2 last month, but remained well above the 50-mark separating growth from contraction.

The survey also showed that supply chain disruption continued to push up firms' costs - a development that could mean a pick up in inflation, widely viewed as transitory by major central banks including the ECB - could last longer than anticipated.

If that was the case, policymakers might need to respond by scaling back monetary stimulus, which could drive up sovereign bond yields.

Germany's 10-year Bund yield rose more than 3 basis points after the PMI data, touching a one-week high at -0.457% in its biggest one day rise in just over two weeks.

It was up six bps from six-month lows hit earlier this month.

Other 10-year bond yields in the single currency bloc also rise with Italian 10-year yields rising over 5 bps to a three-week high at 0.601%.

"In general we have a better mood in financial markets and so it's not a surprise to see a bit of a move lower in fixed income markets," DZ Bank rates strategist Rene Albrecht referring to bond prices, which move down when their yields rise.

"There are also some signs of prices pressure coming through in input prices."

According to the PMI, 87 percent of industrial companies in August said they had to pay more for their inputs. At the same time, many companies passed on increased production costs to customers.

A key gauge of the market's long-term inflation expectations, the five-year, five-year breakeven forward rose to 1.66%. It was up from two-week lows hit late last week, with a 3% rally in oil prices also lifting inflation expectations.

Mounting concerns that the best of the global economic recovery may already be in the past has bolstered major sovereign bond markets in recent weeks.

"It could well be the resilience of services PMIs this morning in the face of the Delta variant but the bigger story in my opinion is supply constraints/inflation hitting manufacturing sentiment," said ING senior rates strategist Antoine Bouvet, referring to the selloff in bond markets.

"This is a developing story and one that has put a cap on interest rates in recent weeks."

(Reporting by Dhara Ranasinghe; Editing by Susan Fenton, Tomasz Janowski and Hugh Lawson)