Bund yields fall near lows after Russian trucks enter Ukraine

Fri Aug 22, 2014 11:33am EDT

* Bund yields below 1 pct, then reverse losses

* Russian aid convoy enters Ukraine without permission

* EU, Nato condemn action but Ukraine says will not use force

* Fed Chair Yellen says remains cautious about rates rise (Adds fresh quote, updates prices)

By Marius Zaharia and John Geddie

LONDON, Aug 22 (Reuters) - German Bund yields dropped close to their record lows below 1 percent on Friday, after Ukrainian authorities said 90 trucks from a Russian aid convoy had crossed the border without permission.

The latest development in the Ukraine crisis, which has led Russia and the West to impose economically damaging sanctions on each other, initially prompted investors to seek refuge in top-rated assets. Market anxiety appeared to abate as the afternoon session ended.

The EU has urged Russia to reverse what it called a clear violation of the border, while Nato said Moscow's actions only worsen the conflict. Ukraine said it will not use any force against the Russian convoy, to avoid provocations.

The Ukraine situation overshadowed a speech by Fed Chair Janet Yellen at an annual central bank conference in Jackson Hole, Wyoming, where she reiterated weakness in the U.S. labour market meant the Bank should move cautiously in determining when interest rates should rise.

"Yellen today has played a bit of a junior role, and geopolitics have come to the fore," Commerzbank rate strategist David Schnautz said.

German 10-year Bund yields were down nearly 3 basis points at the day's low of 0.964 percent after the initial Ukraine shock, coming close to their record low of 0.952 percent. By 1530GMT those losses had been reversed.

European Central Bank President Mario Draghi - who speaks at 1830GMT - is under pressure to use his last remaining policy tool: printing money. The euro zone is faced with near-zero inflation and a stagnating economy, but few strategists expect anything startling from his Jackson Hole speech.

The ECB cut all its interest rates in June and will offer up to 1 trillion euros of cheap four-year loans to banks (TLTROs)from September. Draghi has said he wants to see the results of those measures before taking new steps.

"Slow growth ahead ... will keep hopes up that the ECB will start a full-scale QE programme," said Suvi Kosonen, an analyst at Nordea, referring to quantitative easing, the technical term for central bank asset purchases.

"Draghi will most likely stay dovish, but we expect no promises of new measures at this point with the TLTROs still about to materialise. So no 'whatever it takes' 2.0 coming up today."

FLIPPING FRESH COINS

Other euro zone yields also held relatively steady around historic lows. Spanish and Italian yields were flat at 2.40 percent and 2.59 percent respectively.

Such low borrowing costs for countries that have a combined debt of 3 trillion euros, are struggling to grow and have no inflation raise questions about the sustainability of a two-year-old rally sparked by Draghi's promise in 2012 to do 'whatever it takes' to save the euro.

Some observers such as the Bank for International Settlements, the so-called central bank of central banks, see the rally as a potential bubble which might burst once money gets more expensive, especially in the United States.

But a weak correlation between Spanish and Italian yields with their U.S. counterparts is reassuring.

link.reuters.com/jyw62w

The ECB's stance also helps the euro zone bond market to de-couple from the one across the Atlantic.

"In essence, growth and inflation surprises would help sovereign credit risk through supporting debt sustainability, while the absence of growth and inflation will spur further ECB accommodation," Societe Generale rate strategist Ciaran O'Hagan said in a note.

"So heads, prices rise and tails, yields fall." (Graphic by Monica Ulmanu; Editing by Toby Chopra, Larry King)

FILED UNDER:
A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

Find your dream retirement town

Florida? Hawaii? Reuters has teamed up with Zillow to give you the power to customize a list of your best places to retire.  Video | Full Article