Russia-Ukraine standoff fuels rally in top-rated euro zone bonds
* Bund futures recoup most of last week's losses
* Other higher-rated euro zone bonds also rally
* Yields on lower-rated Spain, Italy hold around eight-year lows
* ECB's Thursday meeting eyed; no policy move expected
By Emelia Sithole-Matarise
LONDON, March 3 (Reuters) - Top-rated euro zone government bonds surged on Monday, outperforming the rest of the market as the threat of war between Russia and Ukraine sent investors scrambling for safe-haven assets.
Ukraine said Russia was building up armoured vehicles on its side of a stretch of water closest to Crimea after Putin declared at the weekend he had the right to invade his neighbour to protect Russian interests.
Western countries have warned they could slap sanctions on Russia, the world's biggest oil producer, if it resorts to military force in Ukraine.
German Bund futures jumped 76 ticks to 145.25, with cash 10-year yields down 7 basis points at 1.55 percent . Dutch, French, Austrian, Finnish and Belgian yields dropped 5-6 bps.
Yields on Italian and Spanish bonds, whose creditworthiness is rated lower, also slipped to close to eight-year lows hit last week on persistent expectations the European Central Bank will ease monetary policy further this year.
The moves in Bunds mirrored a rally in U.S. Treasuries that drove benchmark 10-year U.S. yields to a one-month low of around 2.59 percent.
"The main driver was Ukraine. It was a day (that favoured) primarily the safe havens," said Philip Shaw, chief economist at Investec.
Lower-risk euro zone bonds reversed last week's losses, which were triggered by above-forecast euro zone inflation data that somewhat cooled bets the ECB would ease policy this week.
Inflation nevertheless remains in the bank's "danger zone" below 1 percent, a level that could threaten economic recovery in the euro zone, and way off its target level of just below but close to 2 percent.
While the inflation data is expected to stay the ECB's hand at Thursday's meeting, money markets expect it to loosen policy later this year if price pressures remain weak as forecast.
Some banks, such as BNP Paribas, expect the central bank to embark on a bond purchase scheme similar to the quantitative easing programme pursued by the U.S. Federal Reserve.
Ten-year Spanish and Italian bonds, the main beneficiaries of an investor hunt for higher returns given ultra-low yields in core bond markets, were 0.5 and 2 bps lower at 3.51 and 3.46 percent respectively.
This contrasted sharply with a year ago when lower-rated euro zone bonds were vulnerable to a sell-off whenever investors' appetite for riskier assets soured.
"It looks like now Spain and Italy are also treated as a safe pick-up in a way. It's very positive that even in such a pronounced risk-off environment with Bunds rallying, peripherals are holding their ground, which is quite remarkable when you think back to prior episodes of the debt crisis," said Michael Leister, a senior strategist at Commerzbank.
"Fundamentals have really improved and growth has picked up. The overriding theme is investors believe in the ECB's policies and they are desperate for a yield pick-up, so even in this environment it's a tough trade to short these bonds."
Yields on 10-year Portuguese and Greek bonds, which are held by emerging market investors so are more vulnerable to turmoil in that sector, were up 2 to 4 bps at 4.90 percent and 7.04 percent respectively.
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