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UPDATE 3-French yields slide on election relief, ECB outlook hammers German bonds
April 24, 2017 / 8:29 AM / 4 months ago

UPDATE 3-French yields slide on election relief, ECB outlook hammers German bonds

* Centrist Macron wins first-round French presidential vote

* French/German 10-year yield gap at tightest since December

* Two-year yield gap halves from Friday's levels

* German bond yields soar, BTP/Bund spread tumbles

* Focus turning to ECB rate outlook, ECB meets Thursday (Adds Italian, Greek bonds prices)

By Dhara Ranasinghe

LONDON, April 24 (Reuters) - Centrist Emmanuel Macron's first-round election victory buoyed French government bonds on Monday but German debt, Europe's benchmark, suffered as investors' focus shifted to the prospect of monetary policy tightening in the euro zone.

French yields fell to multi-month lows after Sunday's presidential vote put Macron into the May 7 run-off, in which he is expected to comfortably beat far-right leader Marine Le Pen, and the premium investors demand to hold French over German debt shrank sharply. The result also lifted the euro and European stocks.

That sparked an unwinding of safe-haven bets and, as investors started to factor in rising expectations for an ECB rate hike in early 2018, the German two-year yield was on track for its biggest daily jump since December 2015.

Final voting figures from France's Interior Ministry for Sunday's first-round vote put Macron on 23.75 percent and the anti-EU, anti-euro Le Pen on 21.53 percent.

The result was seen as one of the most market-friendly outcomes, lessening the risk of an anti-establishment shock on the scale of Britain's vote to quit the European Union.

A survey by Opinionway on Monday showed Macron beating Le Pen in the second round by 61 percent to 39 percent.

French 10-year bond yields slid over 10 basis points to more than three-month lows of 0.74 percent, while the yield on Germany's safe-haven 10-year Bund jumped over 10 basis points to a one-month high of 0.37 percent.

That left the gap between the two, a barometer in recent months of French election risks, at its tightest since December at around 40 bps and down from around 62 bps on Friday.

The French/German two-year bond spread halved from where it stood late on Friday to around 20 bps.

"The spread has tightened so much because Macron is through to the second round and the opinion polls were accurate, so markets can take comfort from the projections that Macron will win the presidency in the second round," said Peter Chatwell, head of rates strategy at Mizuho.

Italian bond yields were down 8 bps to an over two-week low of 2.19 percent even though the country's credit rating was downgraded a notch by Fitch on Friday evening.

As one of the most liquid lower-rated euro zone countries, many investors tend to use Italian government bonds to hedge against political concerns in the bloc.

The Italian/German 10-year yield spread, which stood at just over 200 bps last week, fell to around 180 bps -- its tightest level since early March.

Greek 10-year government bond yields also fell sharply on Monday to a four-month low of 6.54 percent on news of a potential bailout agreement and with the country's primary surplus far surpassing targets set by its official creditors.

Worries about the popularity of Le Pen had alarmed investors and fanned concerns about euro zone stability.

Borrowing costs in southern Europe tumbled, led by Portugal, which saw its 10-year government bond yields drop 21 basis points to 3.57 percent.

On Friday, Portugal retained its investment-grade status with ratings agency DBRS, ensuring that the country will continue to benefit from the ECB's bond-buying stimulus.

BATTERED

But there was sharp selling in shorter-dated German bonds as investors bet that falling political risks and a brighter economic outlook could encourage the ECB to wind down its economic stimulus programme sooner rather than later.

Germany's two-year bond yield jumped more than 10 basis points to three-month highs at minus 0.68 percent. It was set for its biggest one-day rise since December 2015.

While the ECB is not expected to deliver any significant changes when it meets on Thursday, money markets also moved to price in a higher chance of a rate rise early next year following the French election results. (Additional reporting by John Geddie; Editing by Catherine Evans)

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