March 5, 2014 / 9:06 AM / in 4 years

Bunds slip before German debt sale, euro zone PMIs

* Demand seen tepid at German 5-year bond sale

* German sale follows “technically failed” 30-year auction

* Italian, Spanish yields outperform top-rated bonds

By Emelia Sithole-Matarise

LONDON, March 5 (Reuters) - Bunds slipped on Wednesday before a sale of German five-year debt that some market participants see drawing tepid demand after a sharp rally over the past month.

The sale of up to 4 billion euros of five-year paper follows a 30-year German bond auction last week which was shunned by investors due to its low potential returns, and 10-year debt sale the week before met similarly poor appetite.

Demand may also be sapped by increased risk-taking ahead of talks between the United States and Russia on easing tensions over Ukraine and on caution before a European Central Bank meeting on Thursday which might see monetary policy unchanged.

Five-year German bonds are particularly sensitive to shifts in expectations on monetary policy and money market prices suggest little chance of further easing from the ECB this week after slightly forecast-beating inflation data last week.

“I don’t expect there to be huge demand at the auction. The five-year is trading quite rich and after recent developments on inflation, the chance the ECB will cut rates this week has diminished,” ING strategist Alessandro Giansanti said.

“German Bunds rallied due to the recent volatility that was due to political reasons but I expect after the easing of geopolitical tensions demand is cooling,” he said.

German 10-year yields, the benchmark for euro zone borrowing costs, was up 2 basis points at 1.61 percent while five-year bonds yielded 1 basis point more than the previous day at 0.64 percent in the secondary market.

Many in the market, however, expect the ECB to loosen policy later this year to support a nascent euro zone recovery and as inflation is predicted to stay way below the central bank’s target of below but close to 2 percent.

Italian and Spanish bonds extended their outperformance of top-rated bonds which has pushed their yields to eight and 8-1/2-year lows respectively this week.

Recent strains in emerging markets (EM) have also fed the bond rally, underpinned by signs of recovery in the euro zone and the ECB’s pledge to buy government bonds, albeit under strict conditions, if a euro zone country gets into trouble.

“We continue to see scope for it (EM crisis) proving positive for peripherals as investors wanting to shift out of EM look for ‘relative’ safety while giving up as little yield as possible,” Rabobank strategist Richard McGuire said.

Spanish and Italian 10-year yields slipped 2 bps to 3.43 percent and 3.40 percent respectively.

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