December 7, 2017 / 9:13 AM / 3 years ago

UPDATE 3-Germany's two-year bond yield falls to three-month low

* “Schatz” yield drops to minus 0.79 pct, lowest since September

* France bond auction well bid despite “richness” of bonds

* EONIA prices fall, but still elevated as distortion persists

* Euro zone periphery govt bond yields (Updates prices)

By Fanny Potkin and Dhara Ranasinghe

LONDON, Dec 7 (Reuters) - Germany’s two-year government bond yield fell to a three-month low on Thursday, as global political uncertainty and anticipation of increased buying by the European Central Bank before the end of the year continued to boost appetite for debt from Europe’s biggest economy.

U.S. Treasury yields fell across the board on Wednesday as risk appetite dwindled after a sell-off in some foreign equity markets and U.S. President Donald Trump’s recognition of Jerusalem as Israel’s capital touched off a storm of protest from world leaders.

That set the tone for the start of the European session. In addition, analysts said, front-loading of ECB asset purchases before the end of the year pushed German yields down.

The ECB said earlier this week it will not purchase bonds as part of its stimulus package from Dec. 21 to Dec. 29, expecting market liquidity will drop around the Christmas holidays.

Germany’s two-year bond yield fell just over a basis point to -0.794 percent, its lowest level since Sept. 8. Ten-year bond yields were a sliver lower and below the 0.30 percent mark, close to three-month lows reached the previous session.

“Overall a moderate risk off tone has crept into markets,” analysts at ING said.

In its last auction of the year, France sold 3.997 billion euros in fixed-rate government bonds, or OATs, on Thursday.

“The bid-to-cover ratios were a bit lower than usual, but all in all it’s a decent auction, especially given the richness of French paper,” said ING strategist Martin van Vliet. “France is the most highly valued government bond at the moment relative to its fundamentals.”

Also, Spain sold 4.1 billion euros ($4.8 billion) of debt at a bond auction on Thursday.

A key overnight benchmark rate that European banks use to lend money to each other remained in focus after surging last week.

The Euro Over Night Index Average (EONIA) was fixed at minus 0.326 percent on Wednesday, down from a high of minus 0.241 percent last week. But it remains elevated, suggesting distortions in the market persist, analysts said.

“We feel affirmed in our suspicion that excess liquidity at a periphery panel bank is rather to blame,” Commerzbank analysts said in a note. “This means that the distortion should become more persistent and the fixing more erratic.”

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=

Reporting by Dhara Ranasinghe, editing by Larry King and David Evans

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