* Gap between French, German yields hits 78 basis points
* Jitters grow over Le Pen's pro-Frexit, anti-EU stance
* Main rivals for presidency respond to allegations
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
(Updates with French finance minister comments)
By Abhinav Ramnarayan
LONDON, Feb 7 Investor concerns that the far
right could win France's presidential vote and take it out of
the European Union pushed the premium investors demand to hold
French government debt over German bonds to its highest since
November 2012 on Tuesday.
The gap between French and German 10-year borrowing costs
widened to 78 basis points in early trades as nervous investors
sought safety in low-risk German government bonds.
Though the spread between the two narrowed as the session
wore on, it remained near multi-year highs.
Bets against French bonds had already risen dramatically in
the wake of Donald Trump's surprise win in the U.S. election in
These have intensified over the past two weeks as support
for conservative challenger Francois Fillon has tumbled in the
wake of a financial scandal. The former prime minister had been
seen as a shoo-in for the Elysee palace before the scandal
erupted, but opinion polls now show him crashing out in the
Fillon has lost ground to independent centrist Emmanuel
Macron and, more alarmingly for investors, the anti-EU National
Front leader Marine Le Pen.
Le Pen promises to haul France out of the euro zone and hold
a referendum on EU membership.
But while Le Pen has long been expected to reach the spring
election's second round, polls show her being soundly defeated
in that runoff.
As political uncertainty grows in France, the relationship
between French and German bonds has weakened while that between
French and lower-rated Italian debt has strengthened, suggesting
French bonds are behaving more like peripheral peers.
The correlation between daily changes in 10-year bond yields
in France and Germany over a 60-day period is now lower than the
equivalen correlation between French and Italian yields.
The last time the correlations crossed over was early 2012
when Italian spreads widened and concerns over a euro breakup
were on the rise, according to Thomson Reuters' IFR.
"LE PEN CAN'T WIN"
"The market is pricing in the tail risk of Le Pen winning
the presidential elections," said DZ Bank strategist Daniel
The phrase "tail risk" refers to an unlikely but potentially
French Finance Minister Michel Sapin weighed in on Tuesday,
saying some investors failed to understand France's electoral
system and Le Pen would not win the election.
"Those who, in good faith or by speculation, bet against
France because they think Le Pen can win are not only wrong, but
I'll be frank: they will lose a lot of money," he said.
While his comments chimed voter surveys, Britain's Brexit
vote and Donald Trump's U.S. election win revealed the depth of
of anti-establishment feeling and highlighted the unreliability
of opinion polls.
BlackRock's global chief investment strategist, Richard
Turnill, said in a note that he believed the risk priced into
European markets around this year's French and German elections
Such sentiment helped push yields lower as the session wore
on, with France's 10-year bond yield down 4 basis points on the
day at 1.10 percent, and the gap to German equivalents narrowing
to 73 bps.
"There is always the conflict between fear and greed," said
Commerzbank strategist David Schnautz. "I guess fear pushed the
yields so high that some investors could not resist."
The cost of insuring against volatility in the euro versus
the dollar over the next three months rose to its
highest in over a week on Tuesday as contracts took in the date
of the final round of France's presidential vote.
French stocks underperformed the pan-European STOXX
600 index, though traders ascribed this to a fall in
banking shares after BNP Paribas shares reported
sub-forecast fourth-quarter profits and its shares fell 4
Doubts over a rescue package for Greece were also stoking
concerns over the future stability of the euro zone.
Greece's two-year bond yield topped 10 percent
for the first time since June on growing worries over whether
the European Union and the International Monetary Fund can reach
an agreement over a third Greek bailout.
(Additional reporting by Vikram Subhedar and Dhara Ranasinghe
and Michel Rose in Paris; Editing by Richard Lough)