4 Min Read
* Two-year German bond yield at new low
* ECB QE, flight-to-quality pin yields lower
* French yields set for biggest weekly fall in 7 months
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds new milestone, updates prices)
By Dhara Ranasinghe
LONDON, Feb 24 (Reuters) - German short-dated government bond yields fell to record lows on Friday, recording their biggest weekly drop since 2011.
The European Central Bank's bond-buying programme and speculation that it will buy more shorter-dated debt for the scheme have helped drive two-year German bond yields down.
That trend has gathered pace along with concern over the French far right's strong polling ahead of presidential elections in April and May. Germany, the euro zone's biggest economy, is the bloc's benchmark bond issuer and its government debt is widely regarded as among the safest assets in the world.
"It's very hard to decompose all the elements behind the fall in two-year German bond yields," said Martin van Vliet, a senior rates strategist at ING.
"A flight to safety is one theme, but there is also the impact of ECB (asset) buying and speculation that it will have to buy more bonds below the deposit rate."
To free up more bonds for its massive stimulus programme, the ECB in December scrapped a rule that prevented it from buying bonds yielding below its -0.40 percent deposit rate.
German yields fell across the curve on Friday, as doubt about the impact of U.S. President Donald Trump's economic policies pushed U.S. bond yields lower.
The two-year Schatz yield fell 5 bps to a record low of minus 0.95 percent. It is set to end the week around 15 basis points lower - a steeper drop than in any single week since December 2011.
ECB stimulus has also contributed to an acute shortage of high-quality bonds for repos, or repurchase agreements.
Banks and big business rely on repo markets to raise cash against collateral, and the ECB is facing pressure to address a squeeze in short-term funding markets.
"There may be an element of the market testing the ECB's nerve," said Richard McGuire, head of rates strategy at Rabobank, referring to the fall in two-year bond yields.
German bond auctions next week could be the next barometer of appetite for its paper, analysts said.
German bonds were not the only market poised to end Friday on a strong note.
A new centrist pact in France's presidential election race that has eased worries about far-rightist Marine Le Pen gaining ground has helped battered French debt recover.
France's 10-year bond yield hit a one-month low at 0.92 percent and was set to end the week with a fall of about 11 bps - its biggest weekly fall since July.
Italian bonds were a relative underperformer.
As 10-year Bund yields hit a near two-month low at 0.18 percent, the gap with Italian peers widened back near three-year highs above 200 basis points.
UniCredit strategist Chiara Cremonesi said that in addition to the strength in German bonds, upcoming supply from Italy was pressuring Italian yields.
"The rally in German bonds and heavy supply from Italy on Monday is why we're seeing the spread widen again," she said.
Editing by Hugh Lawson and John Stonestreet