July 12, 2017 / 8:04 AM / 12 days ago

Worries over U.S. politics and policy drive demand for euro zone bonds

3 Min Read

* Trump Jr. emails, Yellen testimony drive flows to euro zone

* Euro zone bond yields 2-3 bps lower, still near highs

* German 10-year bond auction watched after two-week sell off

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

By Abhinav Ramnarayan

LONDON, July 12 (Reuters) - Concerns over politics and policy in the United States helped drive demand back into euro zone government bonds on Wednesday, pushing yields lower and further away from multi-month highs hit earlier this week.

The euro hit 14-month highs against the dollar as investors, already wary ahead of a speech by U.S. Federal Reserve chief Janet Yellen, digested emails released by President Donald Trump's eldest son suggesting he welcomed Russia's help in last year's election campaign.

"There's a little bit of nervousness in the market after the news overnight from the U.S. and ahead of the Yellen speech," said DZ Bank strategist Christian Lenk. "Also it helps that yields are now at high levels, that might be driving some of the flows."

Yellen will be testifying to Congress on the state of the U.S. economy and markets will be watching the speech closely for any clues on rate hikes and the plan for reducing the Fed's balance sheet.

While the most recent U.S. employment figures beat expectations, economic data from the world's biggest economy has been patchy this year and has generally been outperformed by the euro zone.

On Tuesday, two of Yellen's colleagues cited low wage growth and muted inflation as reasons for caution on further interest rate increases.

BBVA strategist Jaime Costero Denche said the tone Yellen adopts on inflation will be key; an upbeat assessment would imply that the world's most important central bank is primed to go ahead with unwinding post-crisis monetary stimulus.

Higher-rated euro zone government bonds, which are considered amongst the safest financial assets in the world, were lower 1-2 basis points across the curve.

The yield on Germany's 10-year government bond, the benchmark for the region, was 1.5 basis points lower at 0.545 percent.

It is still over double the 0.25 percent level from two weeks ago, when European Central Bank chief Mario Draghi triggered a sharp sell-off in euro zone government bond markets by suggesting the bank was open to policy tweaks.

Wednesday marks the first German auction of 10-year government bonds after this sell off, and as such markets will keep an eye on demand.

A low bid-to-cover ratio could push yields higher.

"This auction result is sure to find interest and interpretation in the market, and could move the bond prices," said Lenk of DZ Bank.

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 Toby Chopra

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