Euro zone bonds take a hit as trade, Brexit uncertainties clear

By Dhara Ranasinghe and Yoruk Bahceli

LONDON (Reuters) - Germany's 10-year bond yield briefly hit a six-month high on Friday on the prospect of a U.S.-China trade deal and as a thumping election win for the Conservative Party cleared hurdles in the way of Britain's exit from the European Union.

Progress towards resolving two key geopolitical risks that have hammered global economic growth this year and anchored safe-haven euro zone bond yields in negative territory lifted investor appetite for riskier assets across markets.

"Of the main risks this year -- Brexit, U.S.-China trade, recession risk -- all three have had their worst effects at worst pushed off over the horizon," said Tim Graf, chief macro strategist at State Street Global Advisors in London.

"That is not to say they are no longer risks, but they are no longer near-term weights on sentiment and the investment narrative."

Germany's 10-year government bond yield briefly touched a six-month high at -0.215%, while Britain's 10-year gilt yield also jumped to a 6-month peak at 0.895% <GB10YT=RR> after a resounding election win for British Prime Minister Boris Johnson's Conservative Party.

The results of Thursday's election will allow Johnson to pass a withdrawal agreement to leave the European Union in a matter of weeks.

Graphic - Bond yields rise as trade, Brexit fog clears: https://fingfx.thomsonreuters.com/gfx/mkt/12/9954/9866/DE131219.png

As the session wore on bond yields drifted lower, with trade-related headlines injecting volatility into markets.

U.S. President Donald Trump said the United States had reached a so-called Phase One trade deal with China in which Washington would suspend tariffs on Chinese imports scheduled for Sunday, while Beijing would step up purchases of U.S. agricultural products.

In late trade most 10-year bonds yields in the single-currency bloc were flat to a touch lower on the day, reflecting caution among investors heading into the weekend.

"Right now, we are so close to the Dec. 15 deadline and no-one wants to take things for granted," said Pooja Kumra, European rates strategist at TD Securities, referring to the recovery in bond markets.

U.S. Treasury yields were broadly lower <US10YT=RR>.

Still, in a sign that the reduced risks from the UK and global trade tensions were positive for global growth and inflation, a key market gauge of long-term inflation expectations in the euro area rose to its highest since mid-September, just shy of 1.30% <EUIL5YF5Y=R>

"The centre of gravity is shifting slowly in bonds markets but it is shifting," said Peter Schaffrik, global macro strategist at RBC Capital Markets.

The gap between Irish and German 10-year bond yields narrowed to around 26 bps <DE10IE10=RR> - its lowest level since early 2018 - reflecting an outperformance of Irish bonds in the wake of Britain's election result.

Graphic - Ireland's 10-year bond yield gap over Germany: https://fingfx.thomsonreuters.com/gfx/mkt/12/9953/9865/IE131219.png

The rally in risk sentiment also boosted southern European markets, with 10-year bond yields tumbling 3-6 bps on the day and set for their biggest weekly falls since September <ES10YT=RR> <PT10YT=RR>.

Italy's 10-year bond yield was last down 6 bps at 1.28% <IT10YT=RR> and is down 16 bps this week.

(Reporting by Yoruk Bahceli and Dhara Ranasinghe; editing by Nick Tattersall and Toby Chopra)