* Weak French PMI data sends Bunds to a three-week high
* Rise limited as euro zone decline slows, led by Germany
* Overall growth fragile, fears may return to hurt periphery
By William James
LONDON, Jan 24 (Reuters) - German bond prices rose to a three-week high on Thursday after French business activity data fell short of expectations and pointed to a recession in the euro zone’s second-biggest economy.
Above-forecast German data slowed the rise in demand for low-risk assets, but diverging fortunes among the region’s largest economies raised concerns that the euro zone’s recovery is vulnerable if Germany is the only source of growth.
Those worries were supported by Spanish figures showing another record high unemployment rate and a rising tide of bad bank loans.
“It was only the French data that was weaker, but we triggered some stops on the way up and that’s exaggerated the move a bit,” a trader said, citing automated buying around recent highs of 143.64/67.
Others added that an increase in demand from central banks, typically more cautious investors, had been supporting German debt prices over recent sessions.
“They still have some concern on the euro zone from a fundamental standpoint,” said BNP Paribas strategist Patrick Jacq.
The Bund future rose 48 ticks to 144.07, reversing an early fall and smashing through the upper limit of a range that had survived several tests since early January.
Technical analysts said a break out of this range could propel the Bund even higher if sustained into the close, with UBS analyst Richard Adcock highlighting a move to 144.38 - the 62 percent retracement of the December to January sell-off.
The market’s initial positioning for data showing an improvement in the euro zone had also meant the focus on the French weakness was greater, analysts said. French bonds themselves were seemingly unaffected by the data, with 10-year yield 2 basis points lower on the day at 2.11 percent.
A string of heavily oversubscribed debt sales by peripheral states over the last two weeks has reinforced confidence that funding problems for the region weaker states have eased.
However, some market participants remain sceptical that the demand is based on improving fundamentals, instead highlighting the huge amount of cash made available by loose central bank policy that needs to be put to work to generate returns.
“The good news for peripherals relies on expectations - we expect the election result in Italy will be market friendly, we expect that Portugal and Spain will be in good condition, and the situation in the euro zone will normalise,” BNP Paribas’ Jacq said. “But this is only expectation. We need to see some materialisation of that.”
Although the rate of decline in the euro zone private sector slowed by more than expected, the growth that the region’s weaker economies like Spain and Italy need to turn around their finances and start reducing debt remains some way off.
Nevertheless, Spanish 10-year bond yields were 5 basis points lower on the day at 5.03 percent, quickly shrugging off an early rise on the back of the record unemployment rate.
Investec analyst Elisabeth Afseth said that over the longer term it would be hard to reconcile the enthusiasm for lower-rated debt issued by peripheral states with the weak growth picture.
“My concern is that there will be tensions further down the line because of this,” she said.
“Nobody is expecting to see this growth immediately, but having said that, the continuing disappointing economic figures aren’t doing anyone any good.”