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

Fri May 2, 2014 12:29pm EDT

* Spanish yields at lowest since 2005

* Bund yields dip on Ukraine turmoil

* Ukraine tension offsets strong U.S. jobs data (Updates with U.S. jobs data, fresh comments)

By Emelia Sithole-Matarise and 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 turmoil in Ukraine to continue their ECB-driven rally.

Peripheral euro zone bonds outperformed higher-ranked peers, which were caught in choppy trade. Yields on higher-rated bonds rose after strong U.S. jobs data, then retreated on growing tension between Russia and Ukraine.

Pro-Russian rebels shot down two Ukrainian helicopters in the south-eastern town of Slaviansk on Friday as Russia reportedly called for a meeting of the United Nations Security Council over the Ukrainian army operation in the town.

Unlike the debt crisis of 2011-12, unrest in Ukraine has failed to rattle peripheral markets. They have gained support from the possibility the European Central Bank will tackle low inflation by buying government debt - in effect, printing money. Inflation was 0.7 percent in April, below forecasts and well below the ECB target of less than but below 2 percent.

"Most gobal bond investors have been, rightly or wrongly, very underweight peripheral bonds ... And so the process we're experiencing now is a neutralising of a lot of those underweight positions," said Rabbani Wahhab, senior fixed income portfolio manager at London and Capital.

"I don't think there's too much left in this spread tightening against (German) Bunds, but we are very aware this might last for just a little while longer but then it's coming towards the end."

Spanish 10-year yields fell 6 basis points to 2.97 percent, the lowest since 2005. A breach below 2.97 percent would take them to record lows, according to Reuters data.

UKRAINE TURMOIL LIFTS BUNDS

Equivalent Irish and Italian yields were around 4 bps lower on the day. Portuguese yields slipped 2 bps to 3.62 percent before a government meeting this weekend to decide whether to exit its bailout without a precautionary loan programme in place.

Earlier on Friday, Portugal passed a final review by its EU and IMF lenders, paving the way for a smooth exit on May 17 from the 78 billion-euro bailout begun in 2011.

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

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

German 10-year yields, the benchmark for euro zone borrowing costs, dipped 2 bps to 1.45 percent in late trading as tension between Ukraine and Russia grew.

The geopolitical strains reversed an initial rise in the yields to 1.51 percent after a surge in U.S. non-farm payrolls in April bolstered optimism about the U.S. economy and suggested a possible rebound in second-quarter economic activity.

"Presumably, the market got itself short after the U.S. numbers so there's a bit of a flight-to-quality squeeze into the weekend," one trader said.

Traders said the prospect of a long weekend in London, with a bank holiday on Monday, made investors extra cautious, despite Bunds looking "very expensive". (Editing by Larry King)

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