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ECB pledge drives up markets' inflation gauge, German-U.S. yield gap

* Euro 5yr, 5yr forward rate shoots up near 1.80 percent

* U.S./German bond yield gap widest since 1989

* Portugal, Spain, Italy, Ireland yields hit new lows

* U.S. jobs data could raise rate hike chance (Updates prices, adds comment)

By John Geddie

LONDON, March 6 (Reuters) – Euro zone markets’ key inflation gauge shot up on Friday, a sign investors believe ECB bond-buying will succeed in driving up consumer prices, while the gap between U.S. and German borrowing costs reached its widest since 1989.

The five-year, five-year forward breakeven rate , the European Central Bank’s preferred measure of the market’s long-term inflation expectations, was set for its biggest weekly rise in at least 2-1/2 years.

The ECB’s programme of bond purchases with new money, aimed at igniting inflation and growth, starts on Monday.

“We interpret it as a sign of the credibility of (ECB chief) Draghi’s measures,” said Guilhem Savry, investment manager in Unigestion’s Cross Asset Solutions team.

Along with revealing details of the scheme, the ECB forecast on Thursday consumer price growth would rise from zero this year to 1.8 percent in 2017, close to its target of just below 2 percent. The rise in inflation expectations reflects recent more positive euro zone economic data, a rebound in oil prices and the weakening euro, which will make imports more expensive.

The five-year five-year forward, which shows where investors expect 2025 price growth forecasts to be in 2020, rose to 1.798 percent from 1.765 percent on Thursday. It has climbed around 0.15 percent this week — the biggest rise since Reuters started tracking the measure in late 2012.

Euro zone government bond yields fell broadly for a second day. The gap between 10-year German and U.S. bond yields peaked at 1.79 percent in U.S. trading on Thursday, its widest level since May 1989, according to Thomson Reuters’ Datastream. http://link.reuters.com/gyj32w

U.S. jobs data on Friday could harden the case for a near-term interest rate hike, widening the gap further.

It narrowed slightly on Friday to 1.77 percent, with German 10-year yields down 1 basis point at 0.35 percent; U.S. equivalents inched up 1 bps to 2.12 percent.

“The spread can only widen,” KBC strategist Piet Lammens said. “We are coming closer to when the U.S. Federal Reserve will start its tightening cycle, and in Europe we would have just started quantitative easing.”

Portuguese 10-year yields fell 14 basis points to a low of 1.67 percent, while Italian and Spanish equivalents fell 7 bps to lows of 1.26 and 1.18 percent, respectively.

Irish equivalents fell 4 bps to a new record low of 0.84 percent, while all other euro zone bonds were about 2-3 bps lower.

Economists polled by Reuters expect non-farm payrolls to rise by 240,000 in February, slightly down from January’s 257,000 increase.

Analysts said a significant improvement in the unemployment rate or wage growth could raise the chance the Fed will hike rates sooner than expected. The Fed’s next policy meeting is on March 17-18.

(Editing by Louise Ireland)

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