* 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
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates throughout)
By Dhara Ranasinghe
LONDON, April 18 (Reuters) - The gap between short-dated U.S. and German borrowing costs stood at its widest for almost three decades on Wednesday, reflecting a growing divergence in interest rate outlooks for the U.S. and European central banks.
New signs that inflationary pressures in the single currency bloc remain subdued bolstered expectations of a cautious stance from the European Central Bank (ECB).
Portugal’s 10-year bond yield fell to a three-year low, while Italian yields hit their lowest level this year.
Euro zone inflation rose 1.3 percent in March, compared to the same period last year, down from a previous estimate of 1.4 percent, data showed.
On Tuesday, Germany’s ZEW research institute said its index of investor morale plunged to its lowest level for more than five years in April - pushing bond yields down as investors bet a rate rise from the ECB could come later rather than sooner.
There was also support for bonds from UK data, which showed inflation unexpectedly cooled to a one-year low in March, raising some doubts over bets the Bank of England will raise interest rates in May.
In contrast, strong U.S. data this week has reinforced expectations for further rate hikes from the Federal Reserve this year.
The U.S. two-year Treasury yield rose to 2.407 percent on Wednesday, a new decade high. That pushed the gap over German peers to about 298 basis points (bps) - the widest since 1989.
“99 pct of the spread widening is down to the divergence of central bank polices,” Mizuho rates strategist Antoine Bouvet said.
“The market has recently regained optimism that the Fed could tighten policy, driving 2-year U.S. yields higher.”
In Europe, 10-year bonds yields fell 0.5 to 3 bps, once again led by southern Europe.
Spanish, Italian and Portuguese yields continue to march lower thanks to relatively strong economic conditions, confidence that ECB monetary tightening remains some way off and positive news from the banking sector.
Portugal’s 10-year bond yield fell to a three-year low at 1.59 percent, while Italian bond yields hit a four-month low at 1.73 percent.
The ECB meets next week and is not expected to make any major changes. Investor rate-hike expectations have been pushed back in recent months and a move is not anticipated by markets until about mid-2018.
“There is a feeling that there is no rush for central banks to either accelerate the removal of stimulus or hasten the pace of tightening and that is supportive for the likes of the periphery,” Credit Agricole European fixed income strategist Orlando Green said.
Germany sold about 2.5 billion euros of 10-year bonds.
Reporting by Dhara Ranasinghe
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