EURO GOVT-German yields hit 8-month low as ECB hints at rate cut
* ECB President Draghi says ready to act, monitoring data
* Rate cut bets briefly push German Bund yield to 8-mth low
* Spain auction solid, peripheral bond demand remains strong
By William James and Marius Zaharia
LONDON, April 4 (Reuters) - German bond yields touched an eight-month low on Thursday after the European Central Bank was judged to be edging towards a rate cut as the euro zone's economic outlook grows gloomier.
After the euro zone central bank's monthly meeting, ECB President Mario Draghi said he expects economic recovery to kick in later this year but that the bank will monitor incoming data very closely and stands ready to cut rates if necessary.
The ECB held its benchmark interest rate at a record low 0.75 percent as expected.
Traders said pre-meeting positioning showed markets had been hungry for any sign of increased willingness to cut rates and Draghi's opening remarks were seized upon, sending German 10-year yields to their lowest since early August.
However, the dip was partially retraced as speculative investors took profits on the move, and as Draghi's later comments stressed the limited effectiveness rate cuts would have on the region's moribund economy.
"I think the market got a little bit excited initially ... but on reflection I'm not sure there was a huge amount in there that wasn't expected," said Philip Tyson, strategist at ICAP.
Recent data showing the euro zone's economic decline dragging on unabated, combined with uncertainty over the long-term impact of Cyprus's unprecedented rescue model had primed some to expect aggressive rate-cutting rhetoric from Draghi.
But the bank also highlighted its search for other ways to get cash flowing into the real economy.
"There was clear recognition that they've got to look at alternative measures as well ... that reflects a continuing belief in some quarters at the ECB that any additional rate cuts are going to be limited in impact," Tyson said.
German 10-year yields hit a low of 1.237 percent, and stood at around 1.253 percent shortly before the settlement. Bund futures hit their highest since early December at 146.08 before easing back to 145.90.
Although the signals from the press conference were mixed, the ECB was still seen lowering rates this year, analysts said.
"(A rate cut) is unlikely to come next month now, it might even be September. But, we would say a rate cut will come along sometime, it's a question of 'when' rather than 'if' now," said Chris Scicluna, head of research at Daiwa Capital Markets.
Performance among the region's lower-rated sovereigns remained solid with Italian 10-year yields falling 5 basis points to 4.55 percent and equivalent Spanish yields down 1 bp at 4.92 percent.
Earlier in the day, Spain sold more bonds than planned as investors bid heavily for the paper.
Analysts said the backstop provided by the ECB's as-yet untested bond-buying programme had offset any worries about potential fallout from the Cypriot crisis.
Spain was seen especially at risk from contagion from Cyprus due to its fragile banking system. Nicosia's bailout is the first to impose losses on bank depositors and many analysts had feared the move could trigger bank runs across the euro zone.
With no sign that was happening, however, investors jumped on the relatively high yields on offer in Spain.
"The underlying situation has stabilised a bit with the Cyprus crisis getting better," said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers.
"There is still room for rallying in Spanish bonds, probably they could target 330-340 bps in terms of spreads."
Those levels represented the lower end of this year's roughly 60 bps range for Spanish/German 10-year yield spreads. The spread was last at 368 bps.
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