×

South European bonds outperform as strong euro makes investors bolder

* Report shows policymakers concerned over strong euro

* Spanish, Italian 10-year yields 2-3 bps lower on day

* U.S. payroll, manufacturing data could weigh on market

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr

LONDON, Sept 1 (Reuters) - Southern European government bonds were in demand on Friday as investors grew increasingly confident that concern among policymakers over a strong euro will keep the European Central Bank from withdrawing stimulus quickly.

The ECB is expected to announce the end of its 2 trillion euro plus bond-buying scheme later this year, but the strength of the single currency has shifted the outlook for economic growth and inflation in the bloc.

Rapid gains by the euro against the dollar are worrying a growing number of policymakers at the ECB, raising the chance its asset purchases will be phased out only slowly, three sources familiar with discussions told Reuters.

"Central banks don't have clarity about the future development of inflation," said DZ Bank strategist Daniel Lenz. "We don't have a stable pattern at the moment; the ECB would want to have a very clear picture before tapering."

Euro zone inflation rose more than expected in August, data showed on Thursday, but at 1.5 percent was still well below the ECB target of just below 2 percent.

Italian, Spanish and Portuguese bond yields were 2-3 basis points lower on Friday while higher-grade government bonds were flat on the day.

The U.S. Federal Reserve faces similar worries about the sustainability of inflation in the world's biggest economy, and the market will keep a close eye on U.S. non-farm payroll numbers and the purchasing managers index data, both due out later today.

"If oil prices remain at the same levels, the negative base effect will kick in at the end of the and headline inflation will drop again," said Lenz.

Brent crude was 0.59 percent lower at $52.54 a barrel on Friday, yet to show any effect from Tropical Storm Harvey, which has affected the energy industry worldwide as flooded U.S. refiners and closed fuel pipelines threatened to squeeze national supply.

U.S. Treasury prices gained on Thursday after consumer spending data showed continuing low inflation; the core personal consumption expenditures (PCE) price index increased 1.4 percent in the 12 months through July, the smallest year-on-year increase since December 2015.

"We see the impact of US economic data as skewed towards US Treasury weakness," Mizuho analysts said in a note, adding that this could weigh on German Bunds as well.

Both U.S. 10-year Treasury yields and German 10-year Bund yields were largely unchanged on Friday at 2.126 percent and 0.36 percent respectively.

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

(Reporting by Abhinav Ramnarayan; editing by John Stonestreet)