Spanish yields dip below 3 pct in broad euro zone bond rally

Fri May 2, 2014 7:27am EDT

(Updates with new prices, fresh quotes)

By Marius Zaharia

LONDON May 2 (Reuters) - Spanish yields dipped below 3 percent for the first time in nine years on Friday as lower-rated euro zone bonds shrugged off rising tensions between Ukraine and pro-Russian separatists to continue their ECB-driven rally.

Yields on German Bunds, seen as one of the safest assets in periods of political and economic uncertainty, dipped to 11 month lows after Ukrainian troops launched a raid to try to retake a town from pro-Russian separatists.

Unlike at the height of the euro zone's debt crisis in 2011 and 2012, geopolitical tensions failed to rattle peripheral markets this year. Spanish, Italian and Portuguese bonds continued to outperform Bunds on Friday.

The possibility that the European Central Bank could eventually try to tackle low inflation by buying government debt to print money has given strong support to peripheral bond markets. At 0.7 percent, inflation was below forecasts in April and stayed well below the ECB's close-to-2-percent target.

"Investors are still looking for yield, we think there is still room for spreads to tighten," said Felix Herrmann, a market strategist at DZ Bank.

"Peripheral bonds are definitely back on their way to becoming a duration product again," he added, referring to traditional fixed income instruments that are seen as a safer alternative to equities.

Spanish 10-year yields fell 5 basis points to 2.98 percent, the lowest since 2005. A breach below 2.97 percent would take them to record lows, according to Reuters data.

German 10-year yields, the benchmark for euro zone borrowing costs, dipped 1 bps to 1.46 percent.

"We've seen a bit of a risk off move ... because of Ukraine, but the periphery has continued to ... (rally) as if they are not seen as risky assets anymore," one trader said.

Another trader said the prospect of a long weekend in London due to a bank holiday on Monday made investors extra cautious, despite Bunds looking "very expensive."

A key U.S. jobs report later in the day limited the scope for Bund moves in any direction, but analysts say whatever the outcome, Bunds would continue to outperform U.S. Treasuries on the back of the ECB outlook.

Non-farm payrolls probably advanced by 210,000 jobs this month, stepping up from a 192,000-gain in March, according to a Reuters survey of economists.

"If payrolls are strong, the rise in U.S. yields will be much more significant than in European yields," BNP Paribas rate strategist Patrick Jacq said.

"Growth remains subdued (in Europe) and the market remains convinced the trend in inflation is on the downside."

U.S. 10-year yields were 2 basis points higher on the day at 2.63 percent, having dipped about 5 bps on Thursday, when European markets were closed. (Reporting by Marius Zaharia; Editing by Toby Chopra)

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