November 27, 2017 / 8:40 AM / 20 days ago

Euro rally, German politics bolster bloc's bond markets

* Rising hopes of German grand coalition to break deadlock

* Euro rises to 2-month highs vs dollar

* Bond yields broadly lower

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, Nov 27 (Reuters) - Euro zone bond yields nudged down on Monday, with southern Europe leading the way thanks to strength in the euro and reduced political uncertainty in the region after Germany moved a step closer to resolving the country’s political impasse.

Leaders of German Chancellor Angela Merkel’s conservative party agreed on Sunday to pursue a “grand coalition” with the Social Democrats to break the political deadlock in Europe’s biggest economy.

This together with strong economic data last week lifted the euro to two-month highs at $1.1948 early on Monday.

The backdrop was favourable for regional debt markets, where strength in the currency dampens inflation and is seen encouraging the European Central Bank to maintain its ultra-loose monetary policy stance for a longer period.

Bond yields across the single-currency bloc edged down, led by the periphery. Spanish, Italian and Portuguese government bond yields were down about 3 basis points in early trade .

Portugal’s 10-year bond yield, at 1.94 percent, was within sight of around 2-1/2 year lows hit last week at 1.90 percent.

In Germany, 10-year Bund yield dipped 1 basis point to 0.35 percent.

“There is optimism about the formation of grand coalition in Germany and economic surprise indices for the bloc are at an all-time high,” said Antoine Bouvet, rates strategist at Mizuho.

“That means there could be more investment in Europe, driving the currency higher and the corollary to that is for markets expectations for ECB policy has to be more dovish.”

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

Reporting by Dhara Ranasinghe; Editing by Toby Chopra

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