EURO GOVT-Auction, data underpin German Bunds before ECB

* Germany's services sector unexpectedly stagnates in June
* Bunds rise in trading thinned by U.S. holiday
* Solid demand for German 5-year bond at sale
* Markets prepare for ECB rate cut

By Ana Nicolaci da Costa
LONDON, July 4 (Reuters) - Bunds rose on Wednesday after a
German auction was supported by hefty redemption flows, and
services data underpinned concerns the debt crisis is taking a
toll on the region's biggest economy.
Investors also bought into German bonds on expectations the
European Central Bank will cut interest rates on Thursday, which
would put further downward pressure on already low yields.
Solid appetite for 5-year German paper was supported by
almost 40 billion euros of German coupon and redemption
payments, but also underscored the seemingly insatiable demand
for safe-haven debt.
"We got decent demand with a quite high bid/cover ratio and
no tail. It's a good auction ... possibly supported by
expectations of a rate cut tomorrow," Eric Oynoyan, rate
strategist at BNP Paribas.
German Bund futures rose 65 basis points to 142.11
in trading thinned by the Independence Day holiday in the United
States.
German 5- and 10-year government bond yields
were back below the levels hit last Thursday
before euro zone leaders announced measures designed to
stabilise bond markets and stem the debt crisis.
Trade in German bonds has been choppy and a three-week
sell-off helped make prices more enticing, a trader said.
"It was a very good German auction," he said. "There seems
to be appetite for core and semi-core markets at these levels."
Investors bid for 2.7 times the amount of paper on offer,
above an average at five-year auctions in 2012 of 1.87. The
average yield was 0.52 percent, above 0.41 percent at a previous
auction in June but below a 2012 average of 0.73 percent.

ECB WATCH
All of Europe's biggest economies are in recession or
heading that way and there is little sign things will improve
soon, surveys showed on Wednesday.
Germany's services sector unexpectedly stagnated in June,
ending an eight-month period of expansion and reinforcing
expectations of a ECB rate cut on Thursday.
A recent Reuters poll of economists showed the majority
expected the ECB to cut its main rate by 25 basis points to 0.75
percent, while money market traders are evenly split on whether
the central bank will cut the deposit rate, a separate survey
showed. .
"Most of the market expects another announcement...
something extra which is either a cut of the deposit rate,
either another easing of the collateral or something else. So
the market might be slightly disappointed if they only deliver a
rate cut of 25 basis points (in the refi rate)," Achilleas
Georgolopoulos, strategist at Lloyds Bank said.
Investors are also bracing for a key sentiment test on
Thursday when Spain goes to the market for the first time since
the EU summit. It will sell between 2 billion and 3 billion
euros of three bonds maturing in 2015, 2016 and 2022.
.
Spanish bonds have benefited from the summit decision to
allow euro zone rescue funds to recapitalize the region's banks
directly, though plans for the fund to buy bonds in the
secondary market are being opposed by Finland, highlighting
implementation risks.
Spanish bonds came under pressure before Thursday's sale,
with ten-year yields up 8.1 basis points to 6.35
percent.
Investors currently demand more to hold 10-year debt issued
by Spain than by Ireland, which is benefiting from a sovereign
bailout. Irish 10-year debt yielded 6.26 percent.
"The only concern is that (Spain has) ...raised the target
so they are going up to three billion," Georgolopoulos added.
"You need them to raise the full amount, even if that means
they compromise on the yields."
Georgolopoulos expected the auction to go well given the
improved post-summit sentiment towards Spanish debt. But he saw
10-year Spanish yields trading back above 6.50-6.60 percent over
the next couple of months.
Ireland will return to the debt market on Thursday with a
sale of 500 million euros of 3-month bills.