Ukraine tensions push yields on safe-haven Bunds lower

LONDON Wed Aug 6, 2014 3:18am EDT

LONDON Aug 6 (Reuters) - Bund yields fell on Wednesday and an auction of five-year German debt was expected to be firmly bid as investors sought refuge in top-rated assets as Russia appeared to step up military exercises near its border with Ukraine.

Polish foreign minister Radoslaw Sikorski said late on Tuesday Russia has "restored its combat capability" to either put pressure on Ukraine or to enter it, while Ukrainian government forces kept up a military offensive to reclaim lost territory in the country's east.

Russian Prime Minister Dmitry Medvedev threatened to retaliate for the grounding of a subsidiary of national airline Aeroflot because of EU sanctions, with one newspaper reporting that European flights to Asia over Siberia could be banned.

Bund yields fell 2 basis points to 1.15 percent, keeping within touching distance of last month's record lows of 1.11 percent. Bund futures were up 21 ticks on the day at 148.22.

"We're going to trade pretty firm on the back of all this Russian invasion noise," one trader said.

Germany sells up to 3 billion euros of five-year debt later in the day and a downbeat inflation outlook is also expected to contribute to solid demand.

The European Central Bank meets on Thursday, but it is not expected to tweak policy as it has signalled it first wants to await the results of June's rate cuts and long-term loans to banks (TLTROs) due in September before making further moves.

But it is likely to reinforce its readiness to act if the inflation outlook deteriorated further.

"There is no potential for yields to rise significantly in the near term, given the prospect of dovish comments from the ECB, the TLTROs in September and given that the economy remains weak," said Patrick Jacq, rate strategist at BNP Paribas.

Data showed German factory orders fell 3.2 percent in June, versus expectations of a 1 percent rise.

Italy releases second-quarter gross domestic product data later on Wednesday. The economy, which carries one of the world's largest debt burdens, is expected to have grown by 0.1 percent on the year.

Italian and Spanish 10-year debt yields rose 2 basis points to 2.78 percent and 2.59 percent, respectively. (Reporting by Marius Zaharia, editing by John Stonestreet)

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