LONDON: Euro zone bond yields settled on Wednesday after a sharp rise the previous day caused by a surprise uptick in UK inflation, with investors wary that a similar reading in the United States later could mean a Federal Reserve rate hike was imminent.
Tuesday's UK data, showing core inflation hitting a five-month high, eased some concerns that a wavering Chinese economy would fuel a significant slowdown in inflation on a global scale.
Such worries have pushed yields sharply lower in recent weeks as parts of the market expected the Fed and the Bank of England to set aside any plans for a near-term rate hike. Some analysts and investors even made the case that the European Central Bank might be forced to extend its 1 trillion euro bond buying programme beyond its scheduled end in September 2016.
But euro zone yields held at higher levels on Wednesday even though Chinese stock markets extended their recent plunge.
US inflation data is due at 1230 GMT and minutes from the Fed's last meeting will be released later. Both will be scoured for clues on whether the Fed will raise interest rates next month for the first time in nearly a decade.
Any mention of the slowdown in China or worries about oil prices trading near six-year lows could be seen as a sign the Fed is prepared to wait longer.
"We can have a long period of zero or very low inflation, but the probability of big deflation in Europe has disappeared," said Eric Vanraes, a fixed income portfolio manager at EI Sturdza Investment Funds.
"But the behaviour of central banks in Europe and the US will stay dovish because there is no inflation and no growth.
The central banks are still playing music so you can continue to dance." German 10-year Bund yields held steady at 0.64 percent.
Yields on lower-rated euro zone bonds in Spain , Italy and Portugal were 1-2 basis points lower, having risen 4-9 bps the previous day. They traded at 1.98 percent, 1.79 percent and 2.46 percent, respectively.
Bund futures were 4 ticks higher at 154.86. "The upside surprise in UK inflation put pressure on the Bund future while weaker Asian stock markets provide support," said Benjamin Schroeder, rate strategist at Commerzbank.
"The US CPI release might lead to some stabilisation, but even then the focus might remain more on the near-term developments where commodities continue trading subdued, and an early Fed hike might be feared to turn out as a policy error which could choke off the underlying price momentum."
Fitch upgraded its credit rating for Greece on Tuesday, saying the bailout agreement the country struck with foreign lenders reduced the chance of default.
The rating is now CCC, up from CC. German lawmakers voted in favour of the deal on Wednesday. Greek 10-year yields were 9 basis points higher at 9.37 percent, having fallen from almost 20 percent in the past five weeks.
On the supply side, Germany sold 4.1 billion euros of a new two-year bond, at an yield of minus 0.25 percent.
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