April 18, 2018 / 7:48 AM / 3 months ago

UPDATE 1-Diverging rate views pushes US/German 2-yr yield gap to widest since 1989

* US/German 2-yr yield gap at 298 bps

* Fed rate-hike bets, softer euro zone data push out spread

* Peripheral bond yields fall again

* German to sell 3 bln euros of 10-year debt

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

By Dhara Ranasinghe

LONDON, April 18 (Reuters) - The gap between short-dated borrowing costs in the United States and euro zone powerhouse economy Germany on Wednesday was at its widest in almost 30 years, reflecting a growing divergence in rate outlooks for U.S. and European central banks.

Southern European continued to lead bond yields in the bloc lower and long-dated Portuguese yields hit three-year lows.

The U.S. two-year Treasury yield rose to a fresh decade high in early European trade, rising to 2.407 percent as economic data this week supported a view that the Federal Reserve will deliver further interest rate hikes this year.

In contrast, Germany's ZEW research institute said on Tuesday that its index of investor morale plunged to its lowest level in more than five years in April.

That's the latest sign that the euro zone's strong economic momentum may have peaked, pushing out expectations for a rate rise from the European Central Bank further into the future.

And with Germany's 2-year bond yield trading a touch lower at minus 0.57 percent, the gap with U.S. peers was at 298 basis points - the widest since 1989.

"99 pct of the spread widening is down to the divergence of central bank polices," said Antoine Bouvet, a rates strategist at Mizuho in London.

"The market has recently regained optimism that the Fed could tighten policy, driving 2-year U.S. yields higher," he said, adding that he believed further spread widening was likely to be limited.

The U.S. yield curve on Tuesday was at its flattest in more than a decade, driven by rising short-dated Treasury yields and a fall at the long end.

Still, the gap between 10-year U.S. and German bond yields was at widest since late 2016, at around 234 basis points ,.

Bond yields across the single currency bloc crept lower on Wednesday, once again led by southern European.

Borrowing costs in Spain, Italy and Portugal continue to march lower thanks to a combination of relatively strong economic conditions, confidence that ECB monetary tightening remains some way off and positive signs from regional banks.

On Tuesday, Italian lender Intesa Sanpaolo reached a 3.6 billion euro ($4.45 billion) deal with Swedish group Intrum that will allow it to shed 10.8 billion euros of bad loans from its balance sheet.

Portugal's 10-year bond yield fell to a three-year low at 1.605 percent, while the Italian/German and Spanish/German yield gaps were at their tightest in two weeks .

Reporting by Dhara Ranasinghe Editing by Andrew Heavens

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