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UPDATE 3-German yields hit 18-month highs on jitters over ECB unwinding

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates prices, adds moves in U.S. Treasury yields)

LONDON, July 6 (Reuters) - Germany's 10-year government bond yield hit its highest level since January 2016 on Thursday, comfortably breaching 0.50 percent as minutes of a European Central Bank meeting fanned expectations of an unwinding of central bank stimulus.

The minutes showed ECB rate setters opened the door to dropping from their policy message a long-standing pledge to expand or extend the bank's bond-purchase programme if necessary.

It fit with a speech by ECB President Mario Draghi last week that sparked a sharp selloff in bond markets.

"One novelty in the minutes and in Draghi's recent speech is there seems to be more tolerance for the current low inflation scenario because they are confident this will go gradually higher in the future," said BBVA strategist Jaime Costero Denche.

"Also, despite the fact they say the adjustment (in policy) will be gradual, they are actually talking about an adjustment -- that's very important."

The market has been pondering the potential tapering of the ECB's two trillion euro bond-buying scheme since Draghi's speech.

Although euro zone growth is accelerating, a "steady-hand" policy from the ECB is still needed to revive inflation, its chief economist Peter Praet said on Thursday.

Euro zone bond yields were up 7-10 basis points across the curve, with German five, 10 and 30-year government bond yields at their highest level since January last year, while the euro edged higher.

The yields on Spanish, Italian and Portuguese 10-year government debt -- seen as most vulnerable to a withdrawal of stimulus because they are bought by the ECB -- were also 10-13 basis points higher.

In the United States, Treasury yields rose after an industry report showed the pace of growth in the U.S. economy's service sector accelerated in June.

Minutes released on Wednesday of the most recent U.S. Federal Reserve meeting showed some policymakers favouring a reduction of the balance sheet within a couple of months.

"The bottom line is that more and more investors are growing confident that the Fed will continue its gradual tightening next year," said ING strategist Martin Van Vliet.

Yields may also be affected by large bond sales from France and Spain.

France sold 8.5 billions euros of bonds while Spain sold 4.3 billion euros of debt at auction.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.bi z / c m s / ? p a g e I d = l i v e m a r k e t s

(Editing by Jeremy Gaunt and Alexander Smith)