German bond yields hit post-Brexit highs, sentiment still frail

(Recasts to reflect change in bond yields)

By Dhara Ranasinghe and Abhinav Ramnarayan

LONDON, Sept 13 (Reuters) - German bond yields hit on Tuesday their highest levels since June's Brexit result vote to leave the European Union, reversing early falls, in a sign that sentiment remains fragile after last week's European Central Bank meeting left investors disappointed.

Comments by Federal Reserve Governor Lael Brainard on Monday suggesting there was no rush to raise interest rates had pushed bond yields lower across the region at the start of trade.

But as the session wore on, yields edged back up -- a move that gathered momentum as U.S (Other OTC: UBGXF - news) . Treasury yields rose.

By late European trade, most bond yields across the euro zone were 2-5 basis points higher. Portuguese bond yields were clear underperformers, up 11 bps.

Germany's benchmark 10-year Bund yield rose 2.5 bps to 0.065 percent, the highest level since the results of Britain's Brexit vote in June.

"We had the dovish Fed comments yesterday but there is still concern in the market about central banks coming to the end of the line in terms of their ammunition," said Rabobank fixed income strategist Lyn Graham-Taylor.

Bond markets have come under pressure in recent days from unease about a possible U.S. rate hike this month, news that the Bank of Japan is studying ways to steepen the bond yield curve and disappointment at the lack of action at last week's ECB meeting.

The long-term decline in global bond yields is over and investors are watching out for a likely fiscal expansion in the world's major economies where monetary stimulus has reached its limits, Jeffrey Gundlach, chief executive officer of DoubleLine Capital (Other OTC: CGHC - news) , said on Tuesday.

SOLACE

Earlier in the day, bond markets drew some solace from Brainards's comments.

She (Munich: SOQ.MU - news) said on Monday that she wanted to see a stronger trend in U.S. consumer spending and evidence of rising inflation before the Fed raises rates, and that the U.S. still looked vulnerable to economic weakness abroad.

The comments solidified the view voiced by other U.S. central bankers on Monday that the Fed was in no rush to raise rates.

Futures markets are now pricing in just a 15 percent chance of a U.S. rate increase next week, and if the Fed moves at all this year it will almost certainly be in December.

"Brainard's was the last speech before the blackout period ahead of the Fed meeting, and she is very close to Yellen. So this is a speech that the market can trust as a reflection of Yellen's opinion on a potential rate hike," said DZ Bank analyst Birgit Figge.

Portugal's 10-year yield rose more than 11 bps to 3.31 percent, its highest level since late June. That followed a warning by Moody's that a weak banking sector remained a source of risk to the government.

Analysts said upcoming supply may also have put some upward pressure on Portuguese yields. Portugal is to sell up to 1 billion euros of seven-year and 20-year bonds on Wednesday.

(Reporting by Dhara Ranasinghe)