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UPDATE 1-Euro zone bond yields fall on growing caution over China, economy

Kitco News

* German, French debt yields slip as demand grows

* Analysts say investors are seeking safety

* Euro zone periphery govt bond yields (Adds details, updates with latest prices)

By Tommy Wilkes

LONDON, Jan 10 (Reuters) - French and German government bond yields slipped towards recent two-year lows on Thursday as soft data out of China and caution about the economic outlook boosted demand for top-rated government debt.

The decline in yields followed falls across the board on Wednesday. Strong demand at bond sales by Belgium, Ireland and Portugal was welcomed by investors, who had been worried an avalanche of supply could trigger volatility in the bond market.

Data showed China’s producer prices rose in December at their slowest pace in more than two years, while French industrial production fell more than expected in November. That added to worries the euro zone’s second-biggest economy was faltering amid disruption caused by anti-government protests.

Analysts said yields would be lower if the market wasn’t digesting heavy supply of new government bonds this week.

“If the market wasn’t backing up a bit to take on the supply, yields would be lower than they are,” said Peter Chatwell, rates strategist at Mizuho.

Unlike stock markets, which have recovered since Federal Reserve Chairman Jerome Powell said last week the U.S. central bank might pause in tightening monetary policy, bond investors appear more cautious.

Chatwell said investors had money to put to work coming into 2019 and were buying the euro zone debt deemed the safest because of nerves about the global economy and expectations the European Central Bank could hold off raising rates in 2019.

Money market investors are now pricing in just a 57 percent chance of a euro zone rate increase this year.

Money managers have been “underinvested in euro zone bonds”, he said. “There was money that had been on the sidelines but is now being invested.”

The two-year German bund yield slipped 1 basis point to -0.5890 percent. The benchmark 10-year bond yield fell 2 basis points to 0.1970 percent.

French government bond yields were also lower, with the 10-year yield dropping by 3 basis points to 0.6795 percent.

The edgy mood was heightened by a breakdown in talks between U.S. President Donald Trump and Democratic leaders aimed at ending a shutdown of the U.S. government, said Daniel Lenz, a strategist at DZ Bank.

“It’s already having an economic impact and could explain why yields are a bit lower on the day,” he said.

Optimism over progress in U.S.-China trade talks also faded, knocking sentiment.

Portuguese and Spanish bonds yields also headed lower, with the former down between 4 and 7 basis points. The Spanish benchmark 10-year bond yield fell 3 basis points to 1.47 percent.

Italian government bond yields, which have risen in recent sessions after hitting five-month lows in early January, were mostly unchanged on the day.

The two-year Italian bond yield stood at 0.5030 percent and the 10-year at 2.897 percent. (Reporting by Tommy Wilkes, editing by Larry King and Susan Fenton)

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