(Recasts with US data, strategists' comments, background)
By Emelia Sithole-Matarise
LONDON, May 16 (Reuters) - Euro zone government bonds rallied on Friday after a key U.S. consumer sentiment index tumbled to its lowest in 28 years, reigniting fears weak consumer spending may erode growth, boosting bids for quality fixed income.
Bunds gained despite competition from European stocks for investors' cash as buyers picked up paper at cheaper levels after a three-day sell-off, pushing two-year yields back below the psychologically key 4.00 percent level.
Sentiment was further bolstered after the Reuters/University of Michigan Survey of Consumers said its preliminary index of confidence fell to 59.5 in May, its lowest since June 1980. In April it was 62.6 and economists' median forecasts in a Reuters poll were for a May reading of 62.0.
This helped offset data showing a surprisingly strong rise in U.S. housing starts in April, which had eroded gains in government debt markets earlier in the session.
"The market turned around triggered apparently by the Michigan sentiment figure but I think most likely it's stopping the trend of the last couple of days," said Kornelius Purps, fixed income strategist at UniCredit.
"We had an extremely bearish week which is behind us and the tide is turning a little bit to close out the week," he said.
At 1640 GMT, June Bund futures <FGBLM8> were 43 ticks up at 113.61.
Two-year bond yields <EU2YT=RR> dipped back below 4.0 percent and were last at 3.988 percent, while 10-year yields <EU10YT=RR> were 3.2 basis points lower at 4.174 percent, flattening the yield curve.
Bunds had sold off this week as concerns over rising inflation, particularly in the UK, caused markets to scale back rate cut expectations, while a larger-than-expected increase in German first quarter GDP accelerated the slide on Thursday.
However, signs of softness in U.S. manufacturing and the job market reminded investors the economy there remained weak, giving a boost to Treasuries overnight which in turn pulled Bunds higher early in Friday's session.
"We remain of the belief that the lows for the market in the near term have already been seen and the building blocks are in place for a move higher," said Sean Maloney, a strategist at Nomura in London.
"This may take some time to gain traction however, with sensitivity to the central bank talk we have been seeing still high after the latest inflation run."
Purps at UniCredit however said the bearish trend in fixed income markets was likely to resume as the earnings season draws to a closer without any hard knocks for stock markets and as investor attention turns to a stream of euro zone data due next week, key among them Germany's Ifo business sentiment index.
"There is a risk of further yield increases in the euro area. Certainly the IFO index is key, whether we'll see an increase or another big drop, both are possible and might have a remarkable impact on ECB expectations and the direction of the curve," Purps said.
Euribor rate futures <0#FEI:> showed some signs of stabilising across the 2009 strip, which was the hardest hit by recent selling as investors pushed out rate cut expectations with some even seeing an outside risk of the ECB hiking interest rates this year in the face of rising global pricing pressures.
The central bank faces a tough task as inflation in the single currency bloc is only just below March's 3.6 percent, while growth is expected to slow in response to credit market turmoil, U.S. weakness, high oil and commodity prices and a strong euro.
ECB President Jean-Claude Trichet said on Friday a surplus of capital chasing too few investment opportunities in past years was now partly to blame for the record oil and commodity prices bedevilling the ECB's efforts to control inflation.
His colleague, Governing Council member Axel Weber said in a newspaper interview released late on Thursday that raising interest rates remains an option for the bank. He said updated ECB staff economic projections, to be released at the June rate meeting, would provide a good basis to discuss medium-term interest rate options. [ID:nL15738852].
In the swaps market, the 2/10 year swap curve remained inverted with 2-year swap rates <EURAB6E2Y=> at 4.66 percent and 10-year rates <EURAB6E10Y=> at 4.605 percent. (Editing by David Christian-Edwards)
((Reuters Messaging: emelia.sithole.reuters.com@reuters.net, Email: emelia.sithole@reuters.com; +44 20 7542 6752))
Keywords: MARKETS BONDS EURO
--------------MARKET SNAPSHOT AT 1547 GMT ------------------
Futures continuous contract basis
FUTURES CASH YIELD
THREE MONTH EURO 95.175 (+0.025) 3.955 (-0.018)
TWO-YEAR SCHATZ 103.43 (+0.05) 3.982 (-0.022)
10-YEAR BUND 113.62 (+0.44) 4.174 (-0.032)
30-YEAR BUND 4.655 (-0.032)
Current levels versus prior European close
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LONDON, May 16 (Reuters) - Euro zone government bond futures extended gains on Friday after a report showing that U.S. consumer confidence tumbled to its lowest in 28 years in May.
The Reuters/University of Michigan Survey of Consumers said its preliminary index of confidence fell to 59.5 in May, its lowest since June 1980. In April it was 62.6 and economists' median forecasts in a Reuters poll were for a May reading of 62.0.
The June Bund future <FGBLM8> rose to 113.50 from 113.40 before release of the data. Two-year yields were little changed at 4.005 percent <EU2YT=RR>.
(Reporting by Emelia Sithole-Matarise) ((Reuters Messaging: emelia.sithole.reuters.com@reuters.net, Email: emelia.sithole@reuters.com; +44 20 7542 6752))
Keywords: MARKETS BONDS EURO
LONDON, May 16 (Reuters) - Euro zone government bond futures pared gains on Friday after a surprisingly strong rise in U.S. housing starts in April hinted that the U.S. housing market slowdown may not be as severe as previously thought.
U.S. housing starts in April ran at a 1.032 million-unit annual rate, up from a revised 954,000-unit rate in March, while permits rose 4.9 percent to 978,000 a year from a revised 932,000 in March. Economists surveyed by Reuters had forecast April starts at a 940,000-unit rate and permits at 920,000 a year.
June Bund futures <FGBLM8> briefly fell to a session low of 113.14 from 113.30 before release of the data. They then recovered to 113.31.
(Reporting by Emelia Sithole-Matarise) ((Reuters Messaging: emelia.sithole.reuters.com@reuters.net, Email: emelia.sithole@reuters.com; +44 20 7542 6752))
Keywords: MARKETS BONDS EURO
LONDON, May 16 (Reuters) - Euro zone government bonds pared gains and were almost flat on the day on Friday after European stock markets extended gains.
At 0932 GMT, June Bund futures <FGBLM8> were 6 ticks higher on the day at 113.24, after touching a session high of 113.56.
Two-year bond yields <EU2YT=RR> were flat at 4.005 percent, with 10-year yields <EU10YT=RR> 1.4 basis points higher at 4.221 percent.
"Stocks are going up, the early buying of bonds just seemed to stop but it did seem a bit overcooked once we got to the (113.) 50s," said a trader.
European shares extended gains as pharmaceutical stocks rose and energy shares pushed up as oil neared $125 a barrel. ((Reporting by Kirsten Donovan; kirsten.donovan.reuters.com@reuters.net, +44 20 7542 8675))
By Kirsten Donovan
LONDON, May 16 (Reuters) - Euro zone government bonds recovered some ground on Friday after a 3-day sell-off, tracking U.S. Treasuries higher after softer U.S. economic data, as buyers picked up paper at cheaper levels.
Bunds sold off this week as concerns over growing inflation, particularly in the UK, caused markets to scale back interest rate cut expectations, while a larger-than-expected increase in German first quarter GDP accelerated the slide on Thursday.
However, signs of softness in U.S. manufacturing and the job market reminded investors the economy there remained weak, giving a boost to Treasuries which in turn pulled Bunds higher in after-hours trading as some buyers stepped back in after the sell-off.
"We're just tracking Treasuries higher. The market seems to have a bit of a calmer feel than earlier in the week and we suspect that the lows we saw yesterday may define the parameters of the market for now."
At 0728 GMT, June Bund futures <FGBLM8> were 29 ticks higher from Thursday's settlement close at 113.47. Two-year bond yields <EU2YT=RR> dipped back below 4.0 percent and were last at 3.994 percent, while 10-year yields <EU10YT=RR> were just over a basis point lower at 4.195 percent.
"Really we need to see weaker euro zone data to justify a lot of buying at these levels," said a trader. "(ECB's) Weber has been talking about raising rates and that has put a cat among the pigeons and will cap things for bonds."
European Central Bank Governing Council member Axel Weber said in a newspaper interview released late on Thursday that raising interest rates remains an option for the bank. He said updated ECB staff economic projections, to be released at the June rate meeting, would provide a good basis to discuss medium-term interest rate options. [ID:nL15738852].
Euribor rate futures <0#FEI:> also showed some signs of stabilising across the 2009 strip, which was the hardest hit by recent selling as investors pushed out rate cut expectations.
The 2/10 year swap curve remained inverted with 2-year swap rates <EURAB6E2Y=> at 4.684 percent and 10-year rates <EURAB6E10Y=> at 4.602 percent.
European shares rose early on Friday, while crude oil prices clawed back toward $125 a barrel.
No major data is due in the euro zone. U.S. housing and consumer data are scheduled later in the session [MI/DIARY] <ECON>. (Reporting by Kirsten Donovan; Editing by Stephen Nisbet)
((kirsten.donovan.reuters.com@reuters.net, +44 20 7542 8675))
--------------MARKET SNAPSHOT AT 0730 GMT ------------------
Futures continuous contract basis
FUTURES CASH YIELD
THREE MONTH EURO 95.145 (-0.005) 3.975 (+0.002)
TWO-YEAR SCHATZ 103.41 (+0.03) 3.994 (-0.010)
10-YEAR BUND 113.51 (+0.33) 4.195 (-0.012)
30-YEAR BUND 4.663 (-0.025)
Current levels versus prior European close
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Next: EURO GOVT-Bunds open higher after 3-day sell-off