By Stefano Rebaudo and Samuel Indyk
(Reuters) -Italian bond yields surged on Wednesday after data showed the European Central Bank (ECB) had reduced its holdings of the bonds in the last two months, signalling it did not need to rein in borrowing costs.
The ECB's holding of Italian government bonds held as part of its Pandemic Emergency Purchase Programme (PEPP) shrank by 1.24 billion euros ($1.22 billion) in August and September, likely as a result of bonds maturing and not being replaced.
This followed a 9.76 billion euros increase in the previous two months, when the ECB announced plans to use PEPP reinvestments to prevent yields from rising too far or too fast in countries where they might.
Italy's 10-year bond yield was last up 27 basis points (bps) to 4.465%, on track for its biggest daily jump since March 2020.
The country's two-year yield was up 23 bps to 2.81%.
"The bar for (ECB) intervention is high and this appears to be the view the market is taking, especially with the discussion on QT (quantitative tightening) expected to start soon," said ING senior rates strategist Antoine Bouvet.
Euro zone yields were broadly higher, retracing some of the sharp decline seen recently as investors lowered bets on where interest rates might peak amid concerns about systemic risks and an economic slowdown.
A sharp rate rise in New Zealand was a reminder that central banks remain in tightening mode.
U.S. data showed the services industry slowed modestly in September, while employment surged and a measure of prices paid by businesses for inputs dropped to its lowest since January 2021, suggesting underlying strength in the economy despite rising interest rates.
U.S. private payrolls numbers were not far off consensus forecasts.
Germany's 10-year yield rose 14 bps to 2.03%.
It reached its highest since November 2011 on Tuesday last week at 2.35%.
The yield gap between Italian and German debt widened by 11 bps to 241 bps.
Investors will now focus on U.S. jobs data due on Friday.
"Slower growth in payrolls and wages, or a rise in the unemployment rate, could further fuel positive sentiment regarding Fed policy," said Mark Haefele, chief investment officer at UBS GWM.
He also mentioned that weaker JOLTS data had supported investors' perception that the Federal Reserve's actions are cooling the labour market, one of the preconditions for a pause in rate hikes.
S&P Global's final composite Purchasing Managers' Index (PMI) for the euro zone confirmed that a drop in business activity deepened last month.
"While central banks are reiterating the importance of data dependency, one still has the impression that realised inflation is key, and with current levels of 10%, it is hard to believe European government bonds will continue their bull run over the next few days," UniCredit analysts said.
They also noted that market-based inflation expectations had fallen substantially.
A market gauge of long-term inflation expectations was at 2.16%, after hitting its lowest since the end of July on Monday at 2.06%.
($1 = 1.0148 euros)
(Reporting by Stefano Rebaudo and Samuel Indyk; Editing by Alexander Smith and Mark Potter)