May 5, 2017 / 4:07 PM / in 6 months

UPDATE 2-Pre-French election euphoria spreads across bond markets

* France/Germany bond yield spread tightest in 6 months

* Italian yields set for biggest 1-week drop this year

* German Bund-yield at 6-week high

* Confidence in Macron win lifts sentiment

* Macron extends lead to 62-38 pct ahead of Sunday’s vote

* Euro zone periphery bond yields tmsnrt.rs/2ii2Bqr (Updates throughout)

By Abhinav Ramnarayan and Dhara Ranasinghe

LONDON, May 5 (Reuters) - Confidence that centrist Emmanuel Macron is about to become France’s next president swept across euro zone markets on Friday, boosting lower-rated Italian bonds and pushing the gap between French and German 10-year bond yields to six-month lows.

On the last day of trade before Sunday’s runoff French vote, investors continued to take risk off the table, selling safe-haven German government bonds and snapping up riskier peripheral debt.

European stocks extended their gains, with France’s blue-chip stock index scaling a new 9-1/2 year high.

Macron is seen winning 62 percent of the vote in Sunday’s second round compared to 38 percent for far-right Marine Le Pen, a poll showed on Friday - also the final day of the election campaign.

The French/German 10-year bond yield gap tightened to a six-month low of 35 basis points, extending moves seen on Thursday after Macron emerged as the more convincing candidate in a TV debate with Le Pen and a poll showed his En Marche movement set to become the largest party in June parliamentary elections.

The yield on Germany’s benchmark 10-year Bund, viewed as one of the safest assets in the world, rose 3 basis points to a six-week high at 0.42 percent.

But the most eye-popping moves came in peripheral bond markets, which had suffered in recent months from euro zone break-up risks as investors worried about the popularity of the anti-euro Le Pen.

Italy’s 10-year bond yield slid 8 basis points to 2.16 percent and was on track for its biggest one-week fall this year.

Like France, Italy’s bond market had also been hurt by concerns about the popularity of anti-establishment parties. After France, elections in Italy in early 2018 if not sooner, have been viewed as the next big risk event for markets with eurosceptic 5-Star Movement polling well.

“Whether we are asking hedge funds or real money or U.S. investors or UK investors, it seems that far too many people have been short and bearish on this simplistic idea that it is Italy’s turn next,” said Mark Dowding, portfolio manager at BlueBay Asset Management.

“But we are talking about an election that is a good 10 months or so away and also even if 5-Star is the biggest party, they’ll still be in coalition, and they appear to have been moderating their stance with regard to EU membership.”

Portugal’s 10-year bond yield tumbled to a six-month low at 3.38 percent, and Spanish yields were down 4 bps at 1.55 percent.

“VERY GOOD WEEK”

“Peripherals have had a very good week as concerns of an upset (in the French election) have dissipated and Italy has lagged the move so I can see why it is the focus today,” said Rabobank strategist Richard McGuire.

“A Macron victory is a positive for Italy - but I do think from a longer strategic viewpoint as we get closer to Italian elections that (Italy-Germany) spread could shift again.”

Ratings agency S&P Global on Friday confirmed Italy’s credit rating at BBB- with a “stable” outlook, saying it expected Italy’s economic recovery will “remain on track”.

Italy’s service sector grew in April at its fastest rate for almost a decade, bolstering prospects for near-term economic growth, a survey showed on Thursday.

“Italy is still a problem child, but the PMI numbers were much better than in previous months and it seems that this year could turn out to be a positive one for the European economy,” DZ Bank rates strategist Daniel Lenz said.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

Additional reporting by John Geddie, editing by Ed Osmond

Our Standards:The Thomson Reuters Trust Principles.
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