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France's yield hits six-week high over Germany as Melenchon makes gains
April 10, 2017 / 8:09 AM / in 4 months

France's yield hits six-week high over Germany as Melenchon makes gains

* Uncertain presidential vote pushes French-German spread higher

* Low-rated euro zone govt bonds sell off on political worries

* Policy, geopolitics keep Bund yields close to one-month lows

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Abhinav Ramnarayan

LONDON, April 10 (Reuters) - France's borrowing costs hit their highest level over Germany in six weeks on Monday as investors fretted over the rise of far-left candidate Jean Luc Melenchon in polls before this month's presidential vote.

Melenchon's emergence over the past week has raised the possibility that he will square off against far-right leader Marine Le Pen in the decisive second round in May, making the final result far more unpredictable.

"The market is focusing a bit too much on the extreme possibilities, but I guess with the elections coming up so soon some nerves are inevitable," said DZ Bank strategist Christian Lenk. "But at the end of the day I think (the second round) will be Macron versus Le Pen."

The gap between French and German bond yields has shot wider in recent months on the possibility that Le Pen will win the keys to the Elysee Palace and try to take France out of the single currency bloc. The spread came off its February highs as centrist Emmanuel Macron made gains and with polls suggesting he would win comfortably in the second round.

But recent polls have shown the race tightening as the front-runners faltered and Communist-backed maverick Melenchon surged after strong performances in two televised candidates' debates.

France's bond yield spread over Germany hit 70 basis points in early trading on Monday, its highest since Feb. 27 .

Investors also dumped low-rated South European government bonds on Monday and yields on Spanish, Italian and Portuguese 10-year bonds were up 4-5 bps on the day.

These "peripheral" bonds tend to perform badly when there are concerns over the future of the euro zone.

A heavy week of supply could also be weighing on government bonds in a shortened week when liquidity would naturally be low anyway, said Lenk. Five euro zone countries are due to sell bonds via auctions this week.

There were yield gains further up the ratings curve as well, but monetary policy expectations and increased geopolitical risk pushed German 10-year yields a touch lower to 0.225 percent, close to one-month lows hit late last week.

Commerzbank analysts attributed this to reduced expectations for rate rises, prompted by dovish comments from European Central Bank policymakers.

ECB President Mario Draghi said on Thursday he saw no need to deviate from the ECB's stated policy path, which includes bond buying at least until the end of the year and record-low rates until well after that.

Demand for low-risk assets also rose after U.S. missile strikes on Syria which have increased tensions in the Middle East and worsened Russia-U.S. relations.

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

Reporting by Abhinav Ramnarayan; Editing by Andrew Heavens

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