By Abhinav Ramnarayan and Fanny Potkin
LONDON (Reuters) - Euro zone government bond yields scaled new multi-year highs on Thursday, as a budget agreement in the United States and a coalition deal in Germany pointed to higher spending on both sides of the Atlantic.
Germany's pro-spending Social Democrats (SPD) are set to head the finance ministry in a coalition government, while U. S. Senate leaders reached a deal on Wednesday to raise spending on military and domestic programmes by almost $300 billion over the next two years.
With two of the world's largest economies now expected to loosen the purse strings in the coming years, investors are watching to see if rate setters expect to tighten monetary policy as a result.
The yield on Germany's 10-year government bond, the benchmark for the bloc, hit 0.808 percent, its highest since September 2015.
"SPD getting the finance ministry (in Germany) means more social expenditure and perhaps also a less restrictive stance on southern Europeans," said DZ Bank strategist Daniel Lenz.
European bond yields' rise towards multi-year highs accelerated at midday after the Bank of England signalled interest rates probably need to rise sooner and by a bit more than it thought three months ago.
BoE-sensitive two-year UK government bond yields rose to its highest since late 2015 on the news, with Gilts rising to multi-year highs overall.
Most 10-year euro zone bond yields were up by 3-7 basis points(bps) in afternoon trades.
Borrowing costs in the region had previously been pulled down by a "safe haven" bid during Tuesday's stock market slump.
Italian, Spanish and Portuguese government bonds underperformed slightly on the day, their yields rising 4-7 bps, having fallen sharply the previous day.
All three are still trading close to their tightest spreads with Germany in months, and in some cases years.
Having a pro-European, pro-spending party at the heart of German government is seen as positive for these southern European countries.
Greece was set to raise 3 billion euros through a sale of seven-year bonds, a deal that should cement Athens' bond market credentials, particularly coming so soon after Tuesday's severe equities market crash.
Thursday also brought speeches by rate-setters from both sides of the Atlantic.
The U. S. Federal Reserve's Patrick Harker said on Thursday he is open to the bank raising key borrowing costs at its March policy meeting, in the wake of market turmoil stemming from worries about rising inflation and interest rates.
Fellow Fed policymaker Robert S. Kaplan had said previously on Thursday that three rate increases this year remain the central bank's base-case scenario regardless of the recent stock market rout.
Elsewhere, the European Central Bank's chief economist, Peter Praet, said the ECB "can live" with the recent spike in market volatility as long as it does not affect the stability of the financial sector.
He also noted that a benchmark salary increase secured by Germany's largest trade union this week was "fully in line" with the ECB's inflation forecasts.
Bundesbank President Jens Weidmann had earlier said that the euro's strength and the recent stock market rout do not justify any substantial extension of the ECB's bond purchase scheme.
(Reporting by Abhinav Ramnarayan, Additional Reporting by Fanny Potkin; Editing by Matthew Mpoke Bigg and David Goodman)
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