May 17, 2018 / 10:06 AM / 7 months ago

REFILE-GLOBAL MARKETS-Government borrowing costs rise as oil goes back to the 80s

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* Oil breaks $80 for the first time since late 2014

* Dollar hits highest since Jan vs the yen, steadies vs euro

* Government borrowing costs grind higher

* Wall Street set for subdued open

* Turkey's lira slides again as EM markets show strains

By Marc Jones

LONDON, May 17 (Reuters) - The dollar took a breather at a five-month high on Thursday, though government borrowing costs continued to grind upwards as oil prices hit their highest since 2014 at $80 a barrel.

Ten-year U.S. government Treasury yields, which are a key driver of global borrowing costs, neared a 7-year high of 3.1 percent as more expensive oil pointed to faster inflation and followed some upbeat U.S. retail sales numbers.

Europe's FX traders saw little movement in the six-currency dollar index but euro/dollar failed to keep above above $1.18 and dollar/yen hit its highest level since late January at 110.70.

"The big turnaround was the Japanese yen, there is clearly big time (U.S. vs Japan) rate sensitivity there," said Saxo Bank's head of FX strategy John Hardy.

"The correlation (between moves in yields and yen) is likely to be one-to-one almost, and without any risk appetite meltdown that should continue."

World and European shares did creep higher but Wall Street futures prices were pointing to a modestly lower start for New York's S&P 500, Dow Jones and Nasdaq when they reopen later.

The other two big macro market spotlights stayed on Italy and Turkey.

Turkey's lira was sliding back towards its recent record lows as concerns persisted about what an expansion of President Tayyip Erdogan's powers could mean if he wins elections next month as widely expected.

It came despite the central bank saying on Wednesday that it would take action against a sell-off in the currency.

Benchmark Italian government bonds and stocks sold off again too following reports, subsequently denied, that the prospective Five Star/League coalition government had drafted an economic plan that would seek 250 billion euros of debt forgiveness from the European Central Bank.

While few people see that as either a realistic proposal or one that would remain in the coalition’s agenda, the tone of the new government’s stance toward euro zone rules was seen as confrontational and spooked some investors.

Markets are now eagerly awaiting the final agreement to see what details remain after a meeting being between the two parties later. Two-year Italian government yields are now back in positive territory for the first time in almost a year – the only other positive yielding two-year euro zone government bond is Greece.

"I'm still sceptical on the euro, there is a lot of headline risk," Saxo bank's Hardy said, adding the worry for lira was that investors will bolt even before they know Erdogan's post- election plans.

BACK TO THE FUTURES

The other major mover was oil which was up at $80 a barrel for first time since late 2014.

With the global economy running at a healthy clip demand remains strong, while U.S. President Donald Trump's plans to re-impose sanctions on Iran could potentially cut global supply by a million barrels a day.

Brent crude futures were last at $80.01 per barrel, up 0.9 percent from their last close with U.S. WTI crude up almost 70 cents at $72.19. Both are now up almost 30 percent since February and 80 percent since June last year.

"The geopolitical noise and escalation fears are here to stay," said Norbert Rücker, head of macro and commodity research at Swiss bank Julius Baer. "Supply concerns are front of mind after the United States left the Iran nuclear deal."

U.S. bank Morgan Stanley meanwhile raised its Brent price forecast to $90 per barrel by 2020 due to a steady increase in demand.

Back in the currency markets, sterling nudged up against both the dollar and the euro after a UK newspaper reported that Prime Minister Theresa May would tell Brussels that Britain was prepared to stay in the European Union's customs union after a transitional arrangement beyond 2021.

Pressure on Mexico's peso returned though as hopes for a new-look NAFTA trade deal with the U.S. and Canada were pushed back and as the country's central bank said its systems had been hit by a 300 million pesos ($15.33 million) cyber attack.

The United States and China also launch trade talks later on Thursday in a bid to avert a damaging tariff war.

The White House's harshest China critic Peter Navarro, the administration's trade and manufacturing adviser, has been relegated to a supporting role, senior Trump administration officials have said. It has followed reports of clashes with U.S. Treasury Secretary Steven Mnuchin.

Additional reporting by Ron Bousso in London; Editing by Toby Chopra

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