RPT-EURO GOVT-Spain yields slip after GDP but reprieve seen brief
* Spain in recession but contraction less than forecast * Thursday's Spanish bond sale seen tougher after S&P cut * German Bund futures could retest record highs By Emelia Sithole-Matarise LONDON, April 30 (Reuters) - Spanish government bond yields slipped on Monday after data showed the country's economy contracted less sharply than forecast but were expected to pick up before debt sales on Thursday, the first since last week's ratings downgrade. Spanish 10-year yields were last at 5.89 percent , about 2 basis points lower on the day. Spain's gross domestic product shrank 0.3 percent in January to March on a quarterly basis, beating economists' forecasts and the Spanish central bank's estimate for a 0.4 percent contraction. The figures will do little to change investors' view that the euro zone's fourth largest economy will struggle to meet budget targets in a recession exacerbated by an ailing banking sector, traders and strategists said. "Even though the Q1 numbers have surprised on the upside in terms of what the central bank had given us in terms of their own estimates, the tendency in the economy is to get worse not better," said Ricardo Barbieri, a strategist at Nomura. "Going forward I will be sticking to an underweight in Spain. I'm not betting on a Spain turnaround," he said. Some strategists and traders said 10-year yields could again breach 6 percent if Spain struggles to sell three- and five-year bonds on Thursday - its first sale since Standard & Poor's downgraded the country's credit ratings by two notches last week. The downgrade pushed yields over 6 percent and a sustained break above that mark could see borrowing costs accelerate to the panic-inducing levels over 7 percent that forced Greece, Portugal and Ireland to seek bailouts. Although Italian debt yields have been caught in the Spanish updraft, Spain looked set to underperform Italy - which has no scheduled bond sales this week - before Thursday's auctions. "We have a strong case for Spain to continue to underperform Italy with Spain under pressure on ratings jitters, upcoming supply, while Italian supply is out of the way," Commerzbank strategist Rainer Guntermann said. The premium investors require to hold 10-year Spanish bonds rather than Italian debt stood at 25 bps, unchanged from late Friday levels. ECB, U.S. PAYROLLS LOOM The fragility in peripheral euro zone debt and nerves over Sunday's French presidential runoff and Greek elections boosted German benchmarks. Investors are also waiting to see if the European Central Bank gives any hints of future support for the market at its policy meeting on Thursday. U.S. non-farm payrolls numbers follow on Friday after weaker than forecast Q1 GDP data bolstered those hoping for further stimulus from the Federal Reserve. The June Bund future was last 34 ticks up at 141.07. It reached a contract high of 141.38 on Friday as Spanish yields briefly topped 6 percent after the S&P downgrade. UBS technical analyst Richard Adcock said a "break above 141.37/38 will be the next bullish signal, opening the door to 141.56, then even the 200 percent extension level at 144.04". German 10-year yields were last 4.3 bps lower at 1.66 percent with some strategists saying they could retest the record low of 1.549 percent hit last Monday with month-end related buying keeping yields subdued. "We would still argue that the market is starting to look a bit stretched but we don't want to catch this falling knife at the moment so we expect yields to stay low and we could even see new lows in coming days," Guntermann said.