German yields hit seven-week highs on improved growth outlook
* Bets euro zone economy improving hurt low-risk bonds
* German yield curve steepens as ECB anchors short end
* Italian, Spanish risk premia at two-year lows
LONDON, Aug 13 (Reuters) - Ten-year Bund yields hit their highest for seven weeks on Tuesday after forecast-beating German data cemented expectations the euro zone was crawling out of a long recession and on signs the U.S. economy was gaining steam. Germany's ZEW investor sentiment index rose more than expected in August, helping reduce the risk premia on bonds issued by Spain and Italy, where subdued growth prospects have been a credit concern throughout the euro zone crisis. The extra yield offered by both Italian and Spanish 10-year debt over benchmark German Bunds hit new two-year lows. "People are feeling more bullish about the economy though it might slow down later on. So the trend here is for higher (Bund) yields," said Gianluca Ziglio, head of fixed income research at Sunrise Brokers. Data due on Wednesday is expected to show the euro zone economy grew 0.2 percent in the second quarter. Ten-year German yields hit their highest since June 26, at 1.82 percent. Bund futures fell 137 ticks to 140.86 - their biggest fall since early March - with the move gaining momentum after firm U.S. retail sales. Yields hit 2013 highs of 1.85 percent in June after the Federal Reserve said it planned to curb monetary stimulus if U.S. data remained strong. They could re-test that level on Wednesday if the euro zone GDP figures beat forecasts. Yields dropped after the European Central Bank pledged in July to keep rates at record lows for a prolonged period or even cut them further - steepening the German yield curve. Two-year German yields rose 5 bps to 0.22 percent, while five-year yields rose 11 bps to 0.79 percent. "The long end is being pushed higher both by improving domestic fundamentals in Europe and the Fed outlook," said Sanjay Joshi, head of fixed income at London and Capital. Recent strong data has not raised expectations the ECB will soon tighten policy though further easing is being priced out. Euribor short-term interest rate futures for 2013 to 2016 fell, indicating three-month Euribor interbank rates were seen higher, suggesting fading chances of a rate cut. "Does the stronger data make a rate cut less likely? I guess it does to some extent, but ... the discussion really has to come about after the political risk has passed in September with the German elections," said Simon Peck, rate strategist at RBS.
TIGHTER SPREADS The improved economic outlook has not hurt bonds in Italy and Spain, where growth is crucial to tackle ballooning public debt. The gap between Italian and German 10-year yields narrowed by 7 bps to 239 bps and the equivalent Spanish spread tightened by 11 bps to 267 bps, both the lowest since July 2011. The spreads have compressed by more than half a percentage point over the past month. They could tighten further in coming weeks, helped by lack of supply pressure after Italy and Spain cancelled mid-August debt sales and by the ECB's conditional promise to buy government bonds if needed, analysts say. Both countries are in strong funding positions, and a top Spanish Treasury official was quoted as saying Madrid will cut the size of its debt sales for the rest of the year after completing 76 percent of its target for 2013 by August. Italy, which has met 80 percent of its target, said it had no plans to reduce supply in coming months. Credit Suisse strategists recommend taking profits at 200 bps in the Italian spread and when Spain's hits 230 bps.