November 16, 2017 / 9:30 AM / 3 years ago

UPDATE 3-French yields close in on German peers on rosy euro zone prospects

* France-Germany yield gap tightest since March 2015

* Monetary policy, international buying seen behind move

* Spain sees over 2 bln euros of demand for 50-yr bond

* Euro zone periphery govt bond yields (Updates prices)

By Abhinav Ramnarayan

LONDON, Nov 16 (Reuters) - The premium investors demand to hold French debt over German peers fell to the lowest in 2-1/2 years on Thursday, nearing record lows.

A rosy economic outlook for the euro zone and the European Central Bank’s easy monetary policy have compressed bond yield spreads.

Since the ECB said in late October it would extend its bond-buying scheme until at least September 2018, the gap between the yields of lower-rated euro zone government bonds and benchmark German debt has been shrinking.

This “spread tightening” was given fresh impetus in recent weeks as data showed the euro zone grew a solid 2.3 percent year-on-year in the third quarter of the year.

“The fact that the ECB extended (bond-buying) by nine months helps create the appetite for semi-core debt and also it looks very attractive for Japanese investors as an alternative to U.S. Treasuries,” said ING strategist Martin van Vliet.

Japanese investors are traditionally one of the largest international lenders to France, owning over 12 percent of French government bonds at the end of last year.

France sold around 5 billion euros of bonds on Thursday via auctions, while Spain sold 4.7 billion euros.

Spain generated over 2 billion euros of demand for 50-year bonds, traditionally a rare and difficult instrument to sell.

Van Vliet said that concerns over potential weakness in the U.S. dollar makes French bonds a more attractive option.

The euro has rallied 13 percent this year and hit a 2-1/2-year high against the greenback in September at near $1.21. It was near $1.18 on Thursday.

The gap between French and German 10-year bond yields tightened to 19 basis points, its narrowest since March 2015.

At this level, van Vliet warned about a potential correction in the weeks to come.

Still, the shrinking French-German bond yield spread marks a turnaround from the start of the year, when concerns over a potential presidential victory for anti-euro candidate Marine Le Pen pushed this gap to a five-year high of over 80 basis points.

French government bonds rallied when pro-European centrist Emmanuel Macron won instead.

This week, Goldman Sachs chief executive Lloyd Blankfein praised the French government for its commitment to economic reforms during a visit to Paris.

Mark Haefele, global chief investment officer at UBS Wealth Management, told the Reuters 2018 Global Investment Outlook Summit on Thursday that Europe had not solved its long-term problems, but strong growth had given the bloc more time to work on them.

“There is a belief that (French President Emmanuel) Macron and (German Chancellor Angela) Merkel - once the ruling coalition has been resolved in Germany - will progress towards a more united Europe,” he said.

Most euro zone bond yields were flat in late Thursday trade, with Germany’s 10-year bond yield hovering at 0.38 percent.

Reporting by Abhinav Ramnarayan; Additional reporting by Dhara Ranasinghe; Editing by Jeremy Gaunt

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