UPDATE 1-Stocks strength dampens demand for euro zone bonds

High-grade euro zone government bond yields rose on Tuesday after European stocks hit a nine-week high, helping boost sentiment and reduce demand for safe haven assets such as German Bunds. A pan-European share index rose 0.8 percent to its highest since Dec. 3 as a recovery in banks, gains in oil stocks and a solid update from BP helped offset other disappointments including from Apple supplier AMS.

In addition, the final release of the euro zone purchasing managers' index survey was better than the initial reading released earlier in the month, even if it still shows that euro zone businesses are expanding at their weakest rate since mid-2013. "While there are still concerns about the global economy, the fact is risk assets are doing quite well this morning which you can see pushing German yields higher," said Mizuho rates strategist Antoine Bouvet.

Germany's 10-year bond yield was 2 basis points higher at 0.20 percent, touching the level for the first time in a week, and a good 5 bps off last week's lows. Other high-grade euro zone were higher 1-2 bps on the day.

Elsewhere, Italian government bond yields came off the day's lows after a survey showed Italy's services sector contracted in January after two months of marginal growth, undershooting expectations it would be flat. Still, however, the positive sentiment around the stock market meant the rise was only marginal, and Italian bond yields were largely flat or slightly lower on the day.

"I would have expected BTPs to sell off more on this PMI, but that said the stars aligning for spread assets because the market is repricing rate expectations," Bouvet said. The Italy 10-year yield is still well away from January's low of 2.56 percent and the closely-watched spread over Germany, at 260 bps, is still 20 bps wider than the levels last week.

Italy went into a recession in the second half of 2018, capping a politically turbulent year. The country's borrowing costs hit a three-week high on Friday when manufacturing purchasing managers' index (PMI) data suggested this economic malaise could continue into 2019.

(Reporting by Abhinav Ramnarayan, Editing by William Maclean and Ed Osmond)

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