June 26, 2014 / 11:01 AM / 3 years ago

German Bund yields dip to lows amid conflict and ECB hopes

* German 10-year yields dip near record lows

* Iraq, Ukraine tensions support safe haven bonds

* Growth forecasts slashed in Italy, Austria

* Moody’s says Spain tax reforms troubling (Adds quote, updates prices)

By John Geddie

LONDON, June 26 (Reuters) - German Bund yields edged towards all-time lows on Thursday amid geopolitical tensions and a weakening euro zone growth outlook which cemented expectations of a prolonged period of central bank support.

Conflict in Iraq and Ukraine supported the bloc’s safest assets, but with borrowing costs for its weakest states still near record lows there was little evidence that investors’ were closing riskier bets.

“The power of the ECB is very high, and the fact they can come with unlimited support to peripheral markets is still making investors scared of taking short positions,” said Alessandro Giansanti, senior rates strategist at ING.

German 10-year yields dipped 1 basis point on Thursday to hit 1.26 percent, nearing the all-time lows of 1.13 percent seen in the summer of 2012.

Strategists said violence in Iraq and a crumbling ceasefire in Ukraine was supporting demand for Bunds as investors worried about the wider impact on the global economy. [ID: nL4N0P70Y0]

“We are close to extremely tight levels in Bunds again... and even some of those that have been holding out are coming in and increasing allocations,” said Alessandro Tentori, global head of rates strategy at Citi.

Others pointed out that with a large number of coupon payments and redemptions next month, German bonds are likely to be one of the main beneficiaries as cash is reinvested.

“At moments like this you don’t think markets will go down,” said one government bond trader.

A second downwards revision of Q1 U.S. economic growth on Wednesday has also fuelled the rally in German Bunds, although Citi’s Tentori said an expected strong rebound in Q2 would likely see a rise in Treasury yields that would reverberate across continents.

UNDERLYING QUESTION

The ill-health of the euro zone economy has helped support demand for sovereign debt across the bloc, as many believe the ECB will eventually be forced to launch an asset-purchase programme - known as quantitative easing - to boost its more conventional monetary policy efforts.

An Italian employers’ lobby and an Austrian think tank both slashed growth forecasts for their respective countries on Thursday, while ratings agency Moody’s said that Spain’s latest fiscal reform proposals weighed on its credit rating.

A preliminary reading of Germany’s June inflation scheduled for Friday will also be closely watched, with the ECB particularly concerned about the effect a slowdown in consumer price rises is having on the bloc’s ability to grow.

Despite the uncertain outlook, Italian and Spanish 10-year yields were unchanged on Thursday at 2.73 percent and 2.64 percent. That is just 3 bps and 9 bps above record lows hit earlier this month, respectively.

There are those, however, that warn that the market is getting ahead of itself and that concerns around the solvency of some of the euro zone’s most indebted states will resurface if growth continues to weaken and fiscal discipline slips.

“Even if these countries are not punished by the market in the short-term, that underlying question is still there,” said Anatoli Annenkov, senior European Economist at Societe Generale. (Editing by Toby Chopra)

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