May 4, 2017 / 8:43 AM / 3 months ago

UPDATE 3-Macron's debate win reassures markets ahead of French election

4 Min Read

* French/German 10-year yield gap narrowest in 6 months

* Two-year French yields tumble to 2-month lows

* Macron firms position in French vote after TV debate

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds details on Spain)

By Dhara Ranasinghe

LONDON, May 4 (Reuters) - The premium investors demand to hold French bonds over German peers was its tightest in six months on Thursday as centrist Emmanuel Macron consolidated his position to win France's presidential race in a TV debate with far-right Marine Le Pen.

Short-dated two-year French debt yields tumbled to two-month lows after a snap opinion poll by Elabe for BFMTV showed 63 percent of viewers found Macron more convincing in the debate on Wednesday preceding Sunday's runoff election.

Markets had already been anticipating a Macron win after his first round victory, and those expectations hardened up after he clashed with Le Pen over their differing views on France's future, the euro and how to fight terrorism.

In addition, the first poll on France's June parliamentary election, published on Wednesday, showed Macron's En Marche! (Onwards!) movement is set to emerge as the largest party.

The OpinionWay-SLPV Analytics poll for newspaper Les Echos found En Marche! on track to win between 249 and 286 seats. Centrist and conservative parties would gain around 200-210 seats, the far-right National Front would win 15-25 and the Socialist left 28-43.

"In France, we still talk about tail risk but that appears to be subsiding after the TV debate," said Commerzbank rates strategist David Schnautz.

Against this backdrop, France sold 8 billion euros of long-dated bonds on Thursday, at the top end of its target range.

Long-term yields rose slightly as markets absorbed the new supply, but performed better than many euro zone peers.

French 10-year yields were 2 basis points higher on the day at 0.76 percent, while German equivalents rose 5 bps to a one-week high at 0.38 percent.

The gap between the two narrowed to around 37 bps, its tightest for almost six months.

That spread has been a gauge of how investors view French election risks. It widened sharply earlier this year as investors fretted about the prospects of a potential win for Le Pen, but narrowed sharply after Macron won the first round vote on April 23.

Shorter-dated French bond yields briefly tumbled to a two-month low of minus 0.549 percent, while a pick-up in risk appetite boosted lower-rated bond markets. Portuguese yields tumbled to six-month lows at 3.42 percent .

Spanish 10-year government bond yields hit a one-month low of 1.58 percent after parliament cleared a key hurdle in approving the long-delayed 2017 budget on Thursday.

The fall in yield came despite an increase in supply: Spain sold 4.7 billion euros of bonds earlier in the day.

The easing of political jitters in France also helped propel French stocks to their highest level since 2008, while the euro rallied 0.5 percent at $1.0935.

"A good showing for Macron on Sunday could make it more likely that his party members will win multiple seats in the National Assembly, which would be a good foundation to deliver his programme of economic reform," said Kathleen Brooks, research director at City Index.

Most other bond yields in the single currency bloc were higher, taking their cue from a rise in U.S. Treasury yields following Wednesday's U.S. Federal Reserve meeting.

The Fed kept interest rates unchanged and played down weak first-quarter economic growth, keeping the possibility of a rate increase in June on the table.

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 Dhara Ranasinghe; editing by Mark Heinrich

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