UPDATE 1-Reflation trades set euro zone bonds for worst week in months

* German 10-year yield set for biggest weekly jump since August

* Italian 10-year yield set for biggest weekly jump since April

* PMIs largely in line with expectations (Rewrites throughout, adds details and charts, updates prices)

AMSTERDAM, Feb 19 (Reuters) – German and Italian bonds were set for their worst weekly performance in months on Friday, driven up by a surge in global bond yields fuelled by expectations of reflation in the United States.

On Friday, Germany’s 10-year yield, the benchmark for the euro area, hit a new high since June 2020 at -0.315%. The yield is up 11 basis points this week, its biggest weekly jump since August.

Those expectations have also boosted real yields in Germany, with the 10-year inflation linked benchmark yield rising to -1.33%, its highest since last November.

“Markets have turned optimistic on the recovery, to a degree that seems warranted in the U.S., but overdone in the euro area,” BofA economists led by Ruben Segura-Cayuela told clients.

“Markets either think the (European Central Bank’s) forecast is too bearish, or they question the ECB’s commitment. Either way, the central bank is called to action. It is now becoming obvious that communication is not clear enough, forward guidance too weak.”

The accounts for the bank’s January meeting showed policymakers were relatively sanguine about a rise in bond yields, saying they remained at historical lows once adjusting for inflation.

Yields in Italy, where Prime Minister Mario Draghi easily won a lower house confidence vote, calmed on Friday, after rising to their highest in January a day earlier.

They were last down about 2 bps to 0.63% — but were up 15 bps this week, their biggest weekly rise since April 2020.

“There is some concern that a violent upward move in rates could unsettle carry trades and in particular Italian bonds but for now reflationary dynamics are positive for Italy,” said Antoine Bouvet, senior rates strategist at ING, adding higher growth and inflation would make Italy’s debt more sustainable.

Data showing business activity shrinking in the euro area did little to change the focus on rising bond yields.

Business activity across the bloc contracted again in February as lockdown measures to contain the coronavirus hammered the bloc’s dominant service industry, first estimate purchasing manager index surveys showed.

Data marginally beat a Reuters poll expecting a slightly bigger contraction.

“The ECB will continue to support European bond markets but as we hear talk of lockdowns being eased, you will see periods when yields move a touch higher,” said April LaRusse, head of fixed income investment specialists at Insight Investment

“What we expect is GDP numbers will look unimpressive for Q2 but once we see some of these economies open up, probably around mid-year, we will get better growth numbers.”

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