© Reuters. The German share price index, DAX board, is seen at the stock exchange in Frankfurt© Reuters. The German share price index, DAX board, is seen at the stock exchange in Frankfurt

By Helen Reid

LONDON (Reuters) – World stocks scaled fresh peaks on Friday while the euro hit a three-year high and Bund yields rose as progress on forming a German government gave fresh impetus to a bond market sell-off triggered by signs the ECB may accelerate an end to its stimulus.

MSCI’s broadest gauge of the world’s stock markets hit yet another record high and was on track to rise for its eighth of the nine business days so far this year — for a total increase of 3.5 percent.

“This bull market is highly related to the fact we are facing good growth, low inflation and soft monetary policy normalization. If any of those were to be shaken that would be a big problem,” said Jeanne Asseraf Bitton, head of cross-asset research at Lyxor Asset Management.

Germany’s 10-year bond yield hit a fresh five-month high of 0.539 percent after Chancellor Angela Merkel’s conservatives and the Social Democrats agreed a blueprint for formal coalition negotiations, news that also buoyed the euro.

European stocks took their cue from a recovery in Asian trading, but were set to end the week on a dud note as a surging euro weighed on European exporters and kept gains on Germany’s muted despite the breakthrough in coalition talks.

MSCI’s index of European stocks index eked out a 0.1 percent gain as the euro hit its highest in three years at $1.2128 and last traded up 0.8 percent at $1.2126.

The euro’s overnight index swap rates have risen sharply this week as traders priced in a higher chance of a rate hike early next year.

While the currency’s rise has reflected growing optimism over the bloc’s economic recovery, investors have flagged it as a potential brake on stocks. Monica Defend, head of strategy at Amundi Asset Management, said the currency, for which she has a target of $1.22, was the biggest risk to European equities.

European bond yields were also driven higher by minutes on Thursday of the ECB’s December meeting that showed it thinks it should revisit its communication stance in early 2018.

Lyxor’s Bitton said Bund yields were already near to hitting her target for the first quarter.

“Markets were a bit too complacent about bonds so they took some excuses to correct,” she said. “We were a little surprised that the market reacted so strongly to the ECB.”

The minutes showed that with the euro zone seeing its best growth in a decade, ECB policymakers were considering a gradual shift in its stance to reduce the focus on bond purchases and raise the emphasis on interest rates.

The ECB has pledged to continue its bond purchase program at least until September, and investors expect any rate hike to take place only next year.

Amundi’s Defend said the gradual removal of liquidity from central banks would drive volatility higher across asset classes this year.

The end of a turbulent week for bond markets also saw U.S. Treasury yields extending Thursday’s pullback after China disputed a media report that government officials had recommended it slow or halt its purchases of U.S. bonds.

The 10-year Treasury yield stood at 2.5498 percent, settling down from Wednesday’s 10-month high of 2.597 percent when fears of a bond bear market gripped investors.

“Our target for U.S. 10-year treasuries is 2.8 — and we might afford up to 3 percent — but going beyond that it’s becoming an alert signal,” said Amundi’s Defend.

The dollar stayed in the doldrums after U.S. wholesale prices dipped in December from November, reinforcing investors’ expectations that inflation will remain low.

The slipped to a six-week low, down 0.5 percent.

flirted with this year’s low, having fallen 11.1 percent on Thursday after the government in South Korea, a major source of digital currency demand, unveiled plans to ban cryptocurrency trading.

It traded at $13,445.00 on the Bitstamp exchange, up 1.5 percent but not far from Thursday’s low of $12,800, which was its lowest since Dec 31.

Oil prices retreated from 2014 highs hit the previous day, but stayed near three-year highs on signs of tightening supply in the United States.

futures hovered at $69.28 a barrel after hitting $70.05 a barrel on Thursday, their highest level since November 2014, while U.S. West Texas Intermediate (WTI) crude futures stood at $63.49, down 0.3 percent on the day.

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