February 21, 2017 / 10:45 AM / 9 months ago

UPDATE 2-Growth surprise raises another French debt dilemma

(Updates prices, adds latest French poll)

By John Geddie

LONDON, Feb 21 (Reuters) - Rebounding euro zone growth data gave investors another reason to sell French bonds on Tuesday as the prospect of the European Central Bank winding down its monetary stimulus combined with nervousness ahead of the French presidential elections.

Investors have been rattled by the prospect of anti-euro, far-right leader Marine Le Pen staging another political surprise in the race for the presidency, with a poll on Monday showing her closing the gap on her centrist opponents.

Yields on French bonds rose 6 basis points to 1.11 percent on Tuesday morning.

The bulk of that move came after data showed euro zone business growth at its fastest in nearly six years, further evidence for those in the ECB calling for the withdrawal of stimulus that has driven up asset prices in recent years.

“It seems that, more and more, investors just want to get out of French bonds and are trying to take advantage of any chance to sell them,” DZ Bank strategist Daniel Lenz said.

More polls on Tuesday kept French bonds on the defensive. An Elabe poll showed the lead of centrist Emmanuel Macron and conservative Francois Fillon over Le Pen in head-to-head polls shrinking to 18 and 12 points respectively.

That suggests the anti-EU Le Pen may have more chance of springing a surprise if, as the polls also suggest, she makes it through to the second round of the elections in May.

While French bond yields were the fastest risers on Tuesday, most other euro zone equivalents climbed around 3 bps.

Short-dated German bonds though - in high demand due to a shortage created by the European Central Bank’s bond-buying scheme - saw yields sink to a new record low with analysts saying investors were parking their cash in one of the safest assets in the euro zone before French elections.

French two-year bond yields rose to minus 0.40 percent , their highest since June. That pushed out the gap over their German equivalents to about 44 basis points, the widest since the 2012 debt crisis.

Meanwhile, the cost of insuring French government debt against default rose on Tuesday to its highest level in more than three years.

Greek bonds were one of the few in demand on Tuesday after Athens and its international lenders agreed on Monday to let teams of experts work out new reforms to Greek pensions, income tax and labour market that would allow Athens to eventually qualify for more cheap loans.

The agreement is a compromise between conflicting views of the IMF, the euro zone and Greece as to how to make the economy more efficient and public finances sustainable.

Yields on short-dated Greek bonds fell more than 1 percentage point to a three-week low of 7.99 percent .

“Yesterday’s Eurogroup change of heart to put more emphasis on deep reforms is key, in our view, implying reduced divergence with the IMF ... and with it much reduced chances that the third bailout will be suspended,” economists at Barclays said in a note.

Editing by Nigel Stephenson and Hugh Lawson

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