German Bund yields hold near record lows as morale survey eyed

LONDON Tue Aug 12, 2014 3:43am EDT

LONDON Aug 12 (Reuters) - German Bund yields stabilised near record lows on Tuesday with investors expecting a sharp fall in a closely watched survey on morale in the euro zone's biggest economy after Western nations imposed sanctions on Russia.

A flight to quality that had pushed Bund yields to all-time lows last week began losing some of its steam after Russia stopped military drills on its eastern border with Ukraine. But tension began to build again with reports that Russia was sending an aid convoy into eastern Ukraine, which could support underlying demand for assets perceived as safe havens.

Economic sanctions between Russia and the West over the violence in Ukraine are expected to take their toll on the euro zone's already feeble economic recovery. Germany's ZEW survey of investor morale will provide the latest snapshot of the potential fallout from Ukraine and the Middle East. The ZEW index is seen falling to 18.2 this month from 27.1 last month.

"We are looking for a hard drop in the index as geopolitics is taking a toll. This comes before second-quarter GDP data on Thursday and this may form a picture that there are cracks in the euro zone recovery," said Commerzbank strategist Rainer Guntermann.

"Against this backdrops there will be fundamental tailwinds for Bunds. We still see Bunds supported even at these low levels in yields ... that's why our recommendation is to stay long in Bunds."

Bund yields, the benchmark for euro zone borrowing costs, were unchanged on the day at 1.07 percent, not far from an all-time low of 1.024 percent reached last week. Yields on other top-rated euro zone bonds were also steady.

Many in the market expect Bund yields to fall further to a low of 1 percent if the slowdown in euro zone growth is confirmed and against the backdrop of a European Central Bank that is holding fire for now on further policy easing.

"Bunds are not expensive at 1 percent if growth momentum is slowing, whilst the ECB continues to make a policy error of timidity at the zero bound. Both conditions need to be reversed for us to sell Bunds and neither seems likely in 2014," RBS strategists said in a note.

Yields on 10-year Spanish and Italian bonds were each 1 basis point up at 2.56 percent and 2.80 percent respectively. (Editing by Larry King)

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