By Elizabeth Howcroft

LONDON (Reuters) – Euro zone government bonds yields slipped in early trading on Friday, stabilising after a sharp sell-off in the previous session, with the German 10-year yield on track for its biggest weekly rise in two months.

Investors are closely watching data for any signs that the economic recovery from COVID-19 is gathering sufficient pace for central banks to start scaling back the extraordinary stimulus since the start of the crisis.

Key benchmark yields hit multi-month highs on Thursday after U.S. economic growth and German inflation data came in higher than expected, strengthening the case for a pullback in central bank stimulus.

The euro zone economy shrank less then expected in the first three months of the year, preliminary data showed on Friday, while headline inflation picked up as expected.

At 1135 GMT, Germany’s 10-year yield was down one basis point at -0.204%, having reached as high as -0.177% in the previous session: its highest since March 2020.

Lyn Graham-Taylor, rates strategist at Rabobank, said that he does not expect the German Bund yield to go significantly higher, and expects the spread between U.S. and euro zone yields to widen as the U.S. economic recovery gathers pace.

Italy’s 10-year yield was down one basis point at 0.861%, compared to its 7-month high of 0.895% in the previous session.

Data from France showed its economy grew more than expected in the first quarter.

A key market gauge of euro zone inflation expectations over the long term – the five-year break-even forward – was at 1.5505%, close to a two-week high.

“The direction of EUR interest rates is no longer in doubt,” wrote ING strategists in a note to clients, citing a jump in European economic confidence indicators and inflation surveys, as well as an accelerating pace of vaccination in Europe. [nL8N2MM6GB]

But the ING strategists also said that they have reservations about the sustainability of faster inflation in the euro zone.

RBC Capital Markets strategists said in a client note that they think “this is only the start of the move back towards the re-opening narrative,” noting that they have added a 10-year U.S. Treasury and 10-year Gilt short position to their portfolio.

(Reporting by Elizabeth Howcroft; Editing by Pravin Char)