(Recasts, updates prices, adds comment)
By Alun John and Harry Robertson
LONDON, Dec 9 (Reuters) - Euro zone government bond yields bounced on Friday as U.S. economic data came in stronger than expected and European banks repaid more loans than anticipated to the European Central Bank.
U.S. producer prices were slightly higher in November than forecast, data showed. Separate data later showed that U.S. consumer sentiment improved in December.
The data called into question bets that the U.S. Federal Reserve, and other central banks such as the ECB, might soon halt their aggressive interest rate hikes.
Germany's 10-year government bond yield, the benchmark for the euro zone, was up 11 basis points (bps) to 1.927% in afternoon trading. Expectations for higher interest rates drive up yields, by causing investors to demand higher returns on bonds.
Many investors are sceptical about the recent fall in bond yields, given that inflation remains high and central banks are set to keep raising interest rates. Germany's 10-year yield hit a 2-1/2 month low earlier this week at 1.753%, dropping from an 11-year high of 2.53% in October.
"I think we've probably gone a bit too far, too quickly," said Nicolas Trindade, senior portfolio manager at AXA Investment Management. "I think there's been a bit of exuberance in the market."
Shorted dated bond yields picked up earlier in the session, as the ECB said euro zone banks were set to repay 447.5 billion euros ($472 billion) of multi-year loans to the central bank, slightly more than expected.
Banks had until recently been sitting on 2.1 trillion euros worth of cash from the ECB's Targeted Longer-Term Refinancing Operations (TLTRO), but are now repaying them.
The ECB raised the borrowing costs on them last month to incentivise repayments, as part of its efforts to combat red-hot inflation.
CENTRAL BANK MEETINGS
The announcement pushed yields on shorter-dated bonds, often used as market collateral, higher on Friday.
Germany's two-year yield was last up 9 bps to 2.149%, while Italy's two-year yield 11 bps higher at 2.646%.
Assets tied up at the ECB as collateral for these emergency loans will now be returned to the market and the excess liquidity, which was created by the loans and is chasing collateral, will also reduce.
That is a relief for euro zone bond markets, which have been plagued by a shortage of bonds for investors to buy after years of ECB purchases.
The spread between interest-rate swaps and Germany's two-year yield tightened in another sign that traders expect scarcity to ease.
"It's a bit hard to know what consensus was, but it's fair to say the (repayment) amount is larger," said Antoine Bouvet, senior rates strategist at ING.
"The market implications are: cash bond yields will underperform (interest rate) swaps - and so that means swap spreads tightening - collateral scarcity around year end might be a bit less acute and this may reassure the ECB and lower the pressure on them to take measures to reduce the balance sheet."
Italy's 10-year yield was up 12 bps at 3.817%. The gap between Germany and Italy's 10 year yields widened 4 bps to 188 bps.
Friday's moves come as investors are starting to position themselves ahead of a busy week of central bank meetings with the Federal Reserve, Bank of England and ECB all meeting and expected to slow their rate hikes to 50 bp moves.
The ECB is also expected to lay out how it will run bonds off its balance sheet, a process known as quantitative tightening, at its policy meeting on Thursday. (Reporting by Alun John and Harry Robertson; Editing by Yoruk Bahceli, Angus MacSwan and Alison Williams)