Ukraine tensions push yields on safe-haven Bunds to record lows
* Investors seek safe havens amid escalation in Ukraine tensions
* German Bund yields on track for biggest daily fall since Sept
* Italy slips back into recession as Q2 GDP unexpectedly shrinks (Updates prices, adds German auction, quote)
By Marius Zaharia
LONDON, Aug 6 (Reuters) - German Bund yields fell to record lows on Wednesday as investors sought refuge in top-rated assets after Russia appeared to step up military exercises near its border with Ukraine.
Data showing Italy unexpectedly slipped back into recession in the second quarter, exacerbating worries about the pace of the euro zone's economic recovery, also fuelled demand for investments perceived as offering a safe haven.
"Geopolitical strains in Ukraine with reports of possible Russian retaliation are fuelling a flight to quality, and adding to the risk sentiment was this disappointing data out of Italy," DZ Bank rate strategist Christian Lenk said. "These two factors justify yields moving back towards record lows."
NATO said on Wednesday that Moscow has amassed around 20,000 troops on Ukraine's eastern border and warned that Russia could use the excuse of a humanitarian or peacekeeping mission to send troops into eastern Ukraine.
President Vladimir Putin has ordered his government to prepare retaliatory measures following the latest round of Western sanctions, which may include banning European airlines from flying over Russian territory.
Bund yields fell 7 basis points to 1.10 percent, a new record low, and were on track for their biggest daily fall since September 2013. Bund futures were up 85 ticks at 148.86.
"We're going to trade pretty firm on the back of all this Russian invasion noise," one trader said.
Germany sold 2.5 billion euros of five-year bonds at much lower yields than at a previous sale, with a downbeat inflation and growth outlook contributing to the solid result.
The European Central Bank meets on Thursday, but is not expected to tweak policy as it has signalled it will assess the effects of June's rate cuts and fresh long-term loans to banks (TLTROs) it will make in September before taking further steps.
But it is likely to emphasise its readiness to act if the inflation outlook should deteriorate 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's economy unexpectedly shrank by 0.2 percent in the second quarter from the first three months of the year, taking it into its third recession since 2008.
Italy, which with Spain was at the fore when the euro zone debt crisis peaked in 2011 and 2012, badly needs growth to help cap one of the world's biggest debt burdens, now standing at over 2 trillion euros. The two periphery countries' fortunes appear to be diverging, after Spain's economy grew 0.6 percent in the second quarter, its fastest pace since 2007.
The West's sanctions on Russia could also act as a drag on Europe through the trade channel. Finland's prime minister said on Wednesday it could potentially go back into economic crisis due to the indirect impact of the sanctions.
The poor economic data, coupled with a general preference for higher-rated assets worldwide due to the tensions in Ukraine, pushed peripheral debt yields higher.
Italian 10-year bond yields rose 6 basis points to 2.82 percent, while Spanish yields rose 4 basis points to 2.60 percent.
"Overall, there should be little doubt that the growth impulse in Italy remains narrow, and a durable exit from the crisis has yet to be confirmed," said Timo del Carpio, European economist at RBC Capital Markets. (Editing by Catherine Evans)