By Tommy Wilkes
LONDON (Reuters) - Euro zone bond yields rose on Monday as investors sold safer assets on the receding risk of a British no-deal exit from the European Union and in the belief that the UK parliament could soon approve a Brexit agreement.
Optimism over Brexit negotiations - last week the EU and Britain agreed a new deal - has fuelled a selloff across euro zone bond markets. Investors think that some sort of resolution to Brexit would help both the euro zone and the British economy.
The deferral of a vote on the withdrawal agreement in the UK parliament on Saturday has done little to reverse that optimism, as lawmakers forced the government to seek a delay to the Oct. 31 deadline for Britain's leaving the EU.
British Prime Minister Boris Johnson will again try to put his deal to a vote in parliament on Monday, although it was not certain the speaker of the House of Commons would allow the vote.
Natixis rates strategist Cyril Regnat said media reports that suggested Johnson could get his deal passed was encouraging investors to buy riskier assets and hurting euro zone bonds in early trading.
However, he said the market should be more nervous, because the threat of a no-deal Brexit remained as long as Brussels did not signal it would delay the Brexit departure date.
"As long as the EU is not ready to send a clear sign of its willingness to extend, I don't see why we should have optimism around risky assets," he said.
Benchmark 10-year German government bond yields extended their rise, gaining as much as 4 basis points to -0.334% (DE10YT=RR), close to three-month highs.
Other core euro zone yields were also higher (FR10YT=RR) (BE10YT=RR) by 4 to 5 bps.
Regnat at Natixis said should a deal be approved by the British parliament, then the 10-year German bond yield could rise to -0.30%, marking a significant reverse from September's record low of -0.743%.
British government bond yields soared on Monday too, gaining between 4 and 8 bps (GB2YT=RR) (GB10YT=RR).
Graphic: British 10-year government bond yield - https://fingfx.thomsonreuters.com/gfx/mkt/12/7636/7567/gilt%20oct%2021.png
Peripheral bonds in Italy, Portugal and Spain were higher (PT10YT=RR) (ES10YT=RR) by 3 to 6 bps.
Analysts said Brexit would remain the dominant driver for euro zone bond markets until economic data released later in the week, including flash purchasing managers' index surveys.
The Brexit optimism and hopes that a downturn in the euro zone economy is bottoming out has also lifted inflation expectations. A key market gauge of long-term euro zone inflation expectations rose to a one-month high of 1.249% .
"The (economic) data are expected to show very mild improvement, confirming that a bottom-building period is on its way," UniCredit strategists said, adding that an improvement in line with expectations was already priced into bond markets.
Investors are also preparing for European Central Bank President Mario Draghi's last policy meeting on Thursday.
While no significant policy shifts are expected, markets will be watching closely for a sense of how deep is a rift among policymakers over renewed asset purchases.