* Spain in recession but contraction less than forecast
* Thursday's Spanish bond sale seen tougher after S&P cut
* German Bund futures could retest record highs
By Emelia Sithole-Matarise
LONDON, April 30 (Reuters) - Spanish government bond yields
slipped on Monday after data showed the country's economy
contracted less sharply than forecast but were expected to pick
up before debt sales on Thursday, the first since last week's
ratings downgrade.
Spanish 10-year yields were last at 5.89 percent
, about 2 basis points lower on the day. Spain's
gross domestic product shrank 0.3 percent in January to March on
a quarterly basis, beating economists' forecasts and the Spanish
central bank's estimate for a 0.4 percent contraction.
The figures will do little to change investors' view that
the euro zone's fourth largest economy will struggle to meet
budget targets in a recession exacerbated by an ailing banking
sector, traders and strategists said.
"Even though the Q1 numbers have surprised on the upside in
terms of what the central bank had given us in terms of their
own estimates, the tendency in the economy is to get worse not
better," said Ricardo Barbieri, a strategist at Nomura.
"Going forward I will be sticking to an underweight in
Spain. I'm not betting on a Spain turnaround," he said.
Some strategists and traders said 10-year yields could again
breach 6 percent if Spain struggles to sell three- and five-year
bonds on Thursday - its first sale since Standard & Poor's
downgraded the country's credit ratings by two notches last
week.
The downgrade pushed yields over 6 percent and a sustained
break above that mark could see borrowing costs accelerate to
the panic-inducing levels over 7 percent that forced Greece,
Portugal and Ireland to seek bailouts.
Although Italian debt yields have been caught in the Spanish
updraft, Spain looked set to underperform Italy - which has no
scheduled bond sales this week - before Thursday's auctions.
"We have a strong case for Spain to continue to underperform
Italy with Spain under pressure on ratings jitters, upcoming
supply, while Italian supply is out of the way," Commerzbank
strategist Rainer Guntermann said.
The premium investors require to hold 10-year Spanish bonds
rather than Italian debt stood at
25 bps, unchanged from late Friday levels.
ECB, U.S. PAYROLLS LOOM
The fragility in peripheral euro zone debt and nerves over
Sunday's French presidential runoff and Greek elections boosted
German benchmarks.
Investors are also waiting to see if the European Central
Bank gives any hints of future support for the market at its
policy meeting on Thursday.
U.S. non-farm payrolls numbers follow on Friday after weaker
than forecast Q1 GDP data bolstered those hoping for further
stimulus from the Federal Reserve.
The June Bund future was last 34 ticks up at
141.07. It reached a contract high of 141.38 on Friday as
Spanish yields briefly topped 6 percent after the S&P downgrade.
UBS technical analyst Richard Adcock said a "break above
141.37/38 will be the next bullish signal, opening the door to
141.56, then even the 200 percent extension level at 144.04".
German 10-year yields were last 4.3 bps lower at 1.66
percent with some strategists saying they could
retest the record low of 1.549 percent hit last Monday with
month-end related buying keeping yields subdued.
"We would still argue that the market is starting to look a
bit stretched but we don't want to catch this falling knife at
the moment so we expect yields to stay low and we could even see
new lows in coming days," Guntermann said.