EURO GOVT-Strong U.S. data hurts Bunds, lifts Spain, Italy debt
* Bund futures fall over a point after U.S. jobs data
* ECB rate cut supports spread tightening against Bunds
* Hunt for yield to drive peripheral yields lower
By Emelia Sithole-Matarise
LONDON, May 3 (Reuters) - German Bunds fell sharply on Friday, underperforming other euro zone bonds after data showed U.S. employment rose more than expected in April, prompting investors to sell low-risk debt.
The U.S. unemployment rate fell to a four-year low of 7.5 percent in April, the U.S. Labor Department said, while nonfarm payrolls added 165,000 jobs last month, beating economists' forecasts.
The report spurred profit-taking in Bunds after they rose to record highs the previous day on bets on further monetary easing from the European Central Bank which saw Austrian and Belgian borrowing costs hit a series of record lows.
Yield spreads over German Bunds in the region were expected to narrow further as investors seek higher returns in other euro zone debt after the ECB cut its refinancing rate on Thursday and President Mario Draghi said it was prepared to cut the deposit rate below zero.
Bund futures fell over a point on the day to settle at 146.15, retreating from an all-time high of 147.20 scaled on Thursday, while German 10-year yields were up 8 basis points at 1.24 percent.
"After the rally we've seen in Bunds I expected some profit-taking. The non farm payroll which was very strong pushed the yields back above 1.20 percent and I expect in the near term we will stay in the middle of a range in the 1.20-1.30 area," said Gianluca Ziglio, a strategist at Sunrise Brokers.
French, Austrian and Belgian 10-year yields also ended the day higher, having fallen earlier to record lows of 1.647 percent, 1.435 percent, and 1.903 percent, respectively.
Debt markets showed limited reaction after ECB policymaker Ewald Nowotny said a negative deposit rate - charging banks for holding their money with the ECB - was not a near-term option. He later said his remarks had been overinterpreted.
Bets of further easing remained intact as "inflation fears are basically vanishing," said Christian Lenk, rate strategist at DZ Bank in Frankfurt.
The Italian/German 10-year yield spread narrowed to its tightest since July 2011 at 251 basis points. Spanish 10-year yields fell below 4 percent for the first time since October 2010, and equivalent Portuguese yields hit 2-1/2 year lows.
"Rate cut speculation is likely to continue to bubble and this is an environment which would keep the periphery supported against a backdrop where you have a search for yield going on. Curves can flatten as well," ICAP strategist Philip Tyson said.
He preferred curve flattening trading strategies that bet on a narrowing of the yield spreads between short- and long-dated bonds in the higher-rated euro zone countries over those that bet on tighter peripheral spreads versus Bunds.
"Spreads of 250 basis points in Italy (versus Germany) was kind of my target area, so I'm not sure how much more narrowing we can see," he said.
The hunt for yield and the ECB's promise to buy bonds via its untested OMT programme if needed "seem to be trumping everything, including fundamentals," Tyson added.