Germany's 10-year yield rises above 1% as markets assess rate hike outlook

Aug 12 (Reuters) - Benchmark German 10-year government bond yields rose above 1% for the first time in two weeks on Friday as markets continued to assess what the U.S. Federal Reserve's next rate hike will look like and Britain's economy slowed less than expected.

Data on Wednesday showed U.S. consumer prices were unchanged in July due to a sharp drop in the cost of gasoline.

The news came as relief to markets, which have seen month after month of higher than expected inflation, and sent bond yields plunging as traders sharply cut their bets on a 75 basis-point (bp) hike from the U.S. Federal Reserve in September.

But several Fed officials have pushed back against the market reaction, emphasizing the bank will continue tightening monetary policy until price pressures are broken. That pushed bond yields back higher from their inflation data-driven fall.

On Friday, Germany's 10-year yield, the benchmark for the euro area, rose above 1% for the first time since July 28. It had fallen as low as 0.68% earlier this month as weak economic data fuelling recession fears had sent bond prices up sharply.

It was last up 3 bps on the day.

"There was an element of catch up needed because Treasuries sold off a bit more post European market close yesterday," said Lyn Graham-Taylor, senior rates strategist at Rabobank.

In contrast to German bonds, 10-year Treasury yields were unchanged on Friday.

Data showing the UK economy contracted much less than expected also put upward pressure on bond yields, with British gilts leading Friday's bond sell-off. Ten-year yields in Britain were last up 5 bps on the day.

"We got used to really high levels of volatility in July, but I think you’ve also got now quite summer markets ... more thin liquidity, might be adding to relatively small (developments), something starts, people jump on the bandwagon, but it's not based on any new market developments," Graham-Taylor at Rabobank said.

In the euro area, where July inflation surprised to the upside, markets have held onto their rate hike bets. Money markets still price in a full probability of a 50 bp hike in September, according to Refinitiv data.

Italian bonds underperformed on Friday, with 10-year yields up 4 bps to 3.06%, pushing the closely-watched risk premium over German bonds to 206 bps, from 203 bps on Thursday. (Reporting by Yoruk Bahceli Editing by Mark Potter)