UPDATE 3-Euro zone bond yields higher on risk sentiment, flash PMIs

(Updates prices, adds market background)

LONDON, Aug 23 (Reuters) – Euro zone bond yields rose on Monday as world stocks rebounded from last week’s selloff 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 that separates growth from contraction.

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

If that were 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 2 basis points at -0.475% by 1524 GMT.

It was up 6 bps from six-month lows hit earlier this month.

Other 10-year bond yields in the single currency bloc also rose, 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 said, 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% 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 have 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.”

On the supply front, Finland hired banks for a 3 billion euro, 5-year bond sale in the first syndication since the summer break, according to a manager memo seen by Reuters.

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