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Euro Zone Bonds Sink, Gilt Market Turmoil Rattles Investors

LONDON, Oct 12 (Reuters) - Euro zone government bond yields rose on Wednesday, tracking weakness in the UK gilts market after the Bank of England governor gave pension funds and other investors three days to fix their problems before it withdraws support.

The BoE has introduced an emergency bond-buying programme in response to a surge in borrowing costs following a package of unfunded tax cuts unveiled by the UK government last month.

The programme runs until Friday. Governor Andrew Bailey said on Tuesday it would not run beyond then, though the Financial Times later quoted three sources as saying the BoE had privately indicated that the buybacks could be extended.

Although the issues affecting the UK bond market are largely domestic, gilts tumbled, pushing 30-year yields to their highest since 2008, which in turn put pressure on the euro zone market throughout the day.

"I would (note) the fact that, within the uptick in Bund yields today, you see the impact of the gilt volatility via a steeper curve, with the short end not doing too much, given that it is not something which necessarily changes the European Central Bank policy outlook. But it is changing the relative pricing of longer-term yields," Standard Chartered head of G10 rates strategy John Davies said.

Yields on the 10-year German Bund , which serves as the regional benchmark, rose as much as 8.7 basis points to a session peak of 2.396%, the highest since August 2011. It was last up 7 bps on the day at 2.308%, while two-year Schatz yields were less volatile, rising 6 bps to 1.845%.

A steeper curve can signal investors are less confident about the longer-term economic outlook.

Ten-year Italian BTP yields , which act as a yardstick for the health of the euro zone's more indebted member countries, rose 11 bps to 4.685%.

With little in the way of market-moving economic data, euro zone debt investors will keep their focus on U.S. inflation readings this week that are likely to cement expectations for more chunky interest rate rises from the Federal Reserve.

Final inflation data is due on Thursday from Germany, but before that, investors will be able to parse through the minutes of the Federal Open Market Committee's most recent meeting later on Wednesday.

U.S. wholesale inflation, excluding food and energy, is expected to have been 7.3% in September, the same as in August. Consumer prices are expected to have moderated to 8.1%, from the previous 8.3% clip, according to economists polled by Reuters.

"Today’s U.S. PPI and Federal Open Market Committee minutes will be reminders that the hawkish Fed juggernaut and strong dollar wrecking ball are the key forces behind the current market volatility. This will be followed by U.S. CPI tomorrow," ING strategists led by Padraig Garvey said in a note.

Editing by John Stonestreet and Mark Heinrich

Source: Reuters

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