June 4, 2014 / 5:05 PM / 3 years ago

UPDATE 1-U.S. data lifts German yields in edgy market before ECB

* German yields rise after strong U.S. services data

* Market edgy before ECB policy meeting on Thursday

* Media reports reiterate ECB dovishness

* Germany avoids third straight auction failure

* Investors still see juice in peripheral rally (Recasts with U.S. data, rise in yields)

By Emelia Sithole-Matarise and John Geddie

LONDON, June 4 (Reuters) - German bond yields rose to near two-week highs on Wednesday after strong U.S. services sector data overshadowed weaker than expected private sector jobs data to show solid growth in the world's biggest economy.

The U.S. services sector grew in May at the fastest pace in nine months as new orders and business activity jumped.

The data came amid nervousness in euro zone bonds before the European Central Bank's policy meeting on Thursday, weighing the risk that the bank may disappoint a market primed for aggressive policy measures to fight potential deflation.

German 10-year yields, the benchmark for euro zone lending, rose 2 basis points to 1.39 percent, near their highest level since mid-May. Still, German bonds continued to outperform U.S. Treasuries, particularly in shorter-dated maturities with the ECB set to ease policy. The 2-year T-note yield premium over German debt is within touch of its highest level since 2010 of 35 bps.

"There was decent ISM services data in the States and that looks to have pulled yields up but everyone is on a bit of a knife-edge heading into the ECB meeting," said Lyn Graham-Taylor, fixed income strategist at Rabobank.

"There's so much priced in that there's room for disappointment. (ECB President Mario (Draghi) has created a bit of a monster and the market is not going to take disappointment very well."

The ECB measures are expected to include an unprecedented cut in its deposit rate into negative territory and measures aimed at boosting lending to small and mid-sized firms (SMEs).

Media reports overnight appeared to underline the ECB's readiness to act at Thursday's meeting as well as signalling future policy action. Bloomberg cited unnamed central bank officials as saying Draghi is likely to say that any rate cut this week won't necessarily be the last even though the deposit rate is expected to move into negative territory for the first time.

One official added that an anticipated scheme designed to boost lending to small and mid-sized firms could offer banks funding equivalent to 5 percent of their outstanding loan portfolios.

"There's already a lot priced into the market and we've seen some people lightening up positions ahead of the ECB. If they just cut rates and do nothing more they could be met by disappointment," said Luca Jellinek, European head of fixed income at Credit Agricole.

SOME JUICE LEFT

In the periphery, Spanish and Italian 10-year yields were up 3-4 bps higher at 2.89 percent and 3.02 percent respectively but still remain just above record lows.

Investors say signs of rebounding economic growth and accommodative central bank policy means there is still value in the bloc's most vulnerable debt securities.

Spain's service sector expanded for the seventh month running in May, while Italy's expanded for the second straight month, data showed on Wednesday.

"We think there is still some juice left," said Philip Poole, head of global research at Deutsche Asset Management.

"With the ECB introducing negative deposit rates, there is a desire on the part of investors for yield and the periphery is still offering decent upside." (Additional reporting by Sujata Rao; Editing by Ruth Pitchford)

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