* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates with periphery rally, Greek news, analyst quote)
By Dhara Ranasinghe and Yoruk Bahceli
LONDON, Sept 18 (Reuters) - Peripheral euro zone government bonds outperformed on Wednesday as relief in oil markets boosted risk appetite, while the market’s focus shifted to the U.S. Federal Reserve to see what measures it flags to address this week’s money market turmoil.
After last week’s ECB rate cut and stimulus package, the Fed is widely expected to lower its target rate later in the day by 25 basis points, to between 1.75% and 2.00%.
Earlier on Wednesday, the Fed funds rate broke above its target range for the first time since the global credit crisis a decade ago. That followed Tuesday’s spike in the overnight repo rate, which implied stress in the dollar funding market.
There was little sign though that these moves were spilling over into the euro-dollar or other currency markets, with the euro-dollar cross currency basis swaps, used by institutional investors to hedge their foreign bond investments, remaining calm.
Analysts said euro zone markets were still benefiting from last week’s European Central Bank easing and from a broad retreat in oil prices on news that Saudi Arabia expects to quickly restore full output after weekend attacks on its oil processing facilities.
Benchmark 10-year bond yields fell across the board with a big rally on peripheral debt.
Greece’s 10-year bond yield hit a record low, dipping 13 basis points to 1.38%.
Greek markets were supported by a Bloomberg story that the country’s banks could be offered 10 billion dollars in state guarantees to help them reduce their bad debt.
Spain’s bond market rallied, with the 10-year bond yield down 7 bps to 0.23% despite news that the country will hold its fourth election in four years on Nov. 10, after rival parties failed to break a months-long impasse in a deeply fragmented parliament.
Analysts said the prospect of a new round of ECB asset purchases, unveiled last week, offset the political uncertainty.
The core reaction was more subdued, with Germany’s 10-year bond yield falling 3 bps to -0.51%, holding below last week’s six-week high of -0.43%.
“No news is good news, while relief in oil on the other hand is also a relief for risk sentiment,” said Commerzbank rates strategist Rainer Guntermann.
A divided Fed is facing pressure from the White House for steep interest rate cuts and an unexpected jump in overnight borrowing costs.
“Everyone knows a rate cut is expected, but we’ll be looking at the statement and the dot plot,” said Pooja Kumra, European rates strategist at TD Securities in London, referring to where policymakers expect rates to be in the future.
“There will also be a lot of focus on what the Fed says about the short-term funding squeeze.”
The cost for banks and Wall Street dealers to borrow dollars in the overnight repurchase agreement market rose as high as 10% on Tuesday. It fell after the New York Federal Reserve said it would conduct a repurchase operation to lower the funding costs.
Analysts said the fall in yields could be related to some speculation that the Fed could expand its balance sheet again soon to help ease a short-term funding squeeze.
Elsewhere, Germany sold 948 billion euros worth of 30-year government bonds against a targeted 1.5 billion euros in another weak sale of its longest-dated bonds. (Reporting by Dhara Ranasinghe and Yoruk Bahceli; Editing by Larry King & Hugh Lawson)