Greek yields dip on report Germany mulling new aid deal
* Report says Germany preparing new aid deal for Athens
* Germany denies any such plan
* Greek yields slip but still near 2014 highs
* ECB seen paving way this week for more easing
* Italy, Spain yields hold steady
By Emelia Sithole-Matarise
LONDON, Feb 3 (Reuters) - Greek bond yields fell on Monday after a news report that Germany's finance ministry is preparing the way for a third bailout for Athens ahead of European elections in May, shrugging off an official denial from Berlin.
Citing a five-page ministry "position paper", Germany's Der Spiegel weekly said the possibilities include a further debt haircut that would mainly hit public creditors or a "limited additional programme" in which Greece could receive fresh money from the European rescue fund.
The German finance ministry denied the report on Monday, but it has prompted speculation that the euro zone's major economies may be willing to act to stave off potential political instability in the bloc's weakest members that may result from gains by eurosceptic parties in the May 22 elections.
"If the core is willing to make overtures to the periphery in the run-up to those elections, that certainly would be of additional support with regards to the periphery spread narrowing trend," said Richard McGuire, a strategist at Rabobank.
Greek 10-year yields were last 13 basis points down on the day at 8.58 percent, retreating from 2014 peaks of 8.90 percent hit last week as an emerging market sell-off spilled over to the southern European country's debt.
Yields on bonds issued by bailed-out peer Portugal were 9 bps lower at 4.96 percent as the turmoil in emerging market currencies lost some steam with Chinese markets still shut for the lunar new year.
Greek bonds were hit by the recent rout led by Turkish and South African currencies as its debt markets are heavily influenced by investors exposed mainly to emerging markets.
Spanish and Italian bonds extended last week's gains on increased expectations that low inflation will lead the European Central Bank to ease policy further in the coming months.
ECB OUTLOOK UNDERPINS DEMAND
Spanish 10-year yields were down 3 bps at 3.64 percent, while Italian equivalents were 2 bps lower at 3.76 percent. Some in the market say the yields look set to fall further, given the improved sentiment in peripheral euro zone markets that could attract yield-hungry investors fleeing emerging markets.
While final reports on euro zone manufacturing activity largely confirmed a recovery in the bloc's major economies, investors' focus was on the next ECB policy move after data last week showed inflation fell to 0.7 percent in January, well below the bank's target of nearly 2 percent.
Many investors expect the ECB to hold fire at its meeting on Thursday but believe it may signal readiness to take accommodative measures in coming months.
"The market is positioned for a dovish message from the ECB on Thursday but we think it's a bit early for them to move on Thursday, given the comments we've heard from some members of the governing council," said Patrick Jacq, a strategist at BNP Paribas in Paris.
German 10-year yields were 1.5 bps up at 1.58 percent after the euro zone data but remained near a low of 1.555 percent hit on Friday.