June 20, 2018 / 10:41 AM / 4 months ago

UPDATE 2-German bond yields pull back from lows on stock market rally

* German Bund yield off 2 1/2-week lows

* World risk appetite picks up

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds Draghi comments, updates prices)

By Dhara Ranasinghe

LONDON, June 20 (Reuters) - German bond yields pulled back from 2 1/2-week lows on Wednesday as world stock markets put aside trade war fears and rallied, taking the shine off safe-haven bond markets.

An escalation in trade tensions between the United States and China, plus dovish rhetoric from the European Central Bank that has boosted confidence a rate hike remains some way off, have pushed down bond yields in recent days.

But having hit more than two-week lows, yields on 10-year bonds in the single currency bloc were unlikely to fall much further without a fresh impetus, analysts said.

In addition, ECB President Mario Draghi said on Wednesday that while not optimistic about an escalation in the trade conflict between the United States and its partners, it is still too early to assess the monetary policy impact

Commerzbank rates strategist Rainer Guntermann said: “I suspect safe-havens such as Bunds and Treasuries could be put to the test as risk sentiment shows signs of stabilising.”

Most 10-year bond yields were little changed on the day. Germany’s Bund yield was steady at 0.37 percent, but above a 2-1/2 week low of 0.35 percent hit on Tuesday.

On the other hand, it was a strong day for stock markets, with a pan-European stock index rising nearly half a percent on the day.

Monetary policy will remain loose even though it is on track to end bond purchases at the end of the year and possibly raise rates next summer, ECB policymaker Francois Villeroy de Galhau said on Wednesday.

Market rate hike expectations have been pushed back by three months to September 2019 since the ECB’s guidance on the outlook for rates at last week’s central bank meeting.

Money market pricing suggests just one 10-basis-point rate hike is fully priced in by investors next year. <ECB WATCH>

There was some outperformance of peripheral bonds after Germany and France on Tuesday agreed to create a budget for the euro zone and hailed a “new chapter” for the currency union.

Italy’s 10-year bond yield briefly dipped to a 2 1/2-week low at 2.536 percent, before rising again. Its spread over Germany was close to its lowest level this month at 218 bps.

Meanwhile, the country’s two-year borrowing costs were 3 bps lower at 0.58 percent.

“Yesterday’s joint statement by France and Germany could help to improve sentiment in the euro zone at the margin,” UniCredit said in a note.

“Combined with last week’s dovish ECB tones, this should provide ongoing support to the periphery. The relative lack of details, however, suggest a cautious approach anyway.”

Elsewhere, Germany sold just over 1 billion euros of 30-year government bonds.

Reporting by Dhara Ranasinghe Editing by Catherine Evans, Larry King

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