* March 15 Dutch election next test for euro zone
* Dutch bonds may be underpricing political risk
* BlackRock, Allianz GI underweight Dutch govt bonds
* Graphic: reut.rs/2h03Dn5
By Dhara Ranasinghe and John Geddie
LONDON, Dec 19 Investors risk being caught
unprepared again by an anti-establishment vote when the
Netherlands, the euro zone's fifth largest economy, goes to the
polls in March.
Surveys point to strong gains for the anti-Islam,
eurosceptic Freedom Party led by Geert Wilders.
Some investors have reduced exposure to Dutch government
debt, saying this partly reflects election uncertainty.
But while Italian bond yields hit 14-month highs before a
Dec. 4 referendum and French yields are near 11-months peaks on
worries about Spring presidential elections, a rise in Dutch
bond yields has been relatively contained.
"The spread (between Dutch and German bond yields) does not
reflect the magnitude of the political risk in the Netherlands,"
said Franck Dixmier, global head of fixed income at Allianz
"Even if the Freedom Party does not win the election, it is
likely to get more seats and start to be more vocal about the
idea of 'Nexit'."
After Britain voted in June to leave the European Union,
Wilders said the Netherlands, one of six founder states of what
is now the EU, should hold its own membership
According to a recent poll, Prime Minister Mark Rutte's
conservative VVD Party would lose nearly half its 43 seats in
parliament if elections were held today, trailing the Freedom
Party by 33 seats to 23. Junior coalition partner Labour could
lose 28 of its 38 seats.
After Britain's shock Brexit vote in June and U.S.
President-elect Donald Trump's unexpected victory last month,
investors have sold the bonds of euro area states seen as
vulnerable to a backlash against the political establishment.
MIND THE GAP
The gap between Dutch 10-year bonds and their
German peers is 14 basis points, having briefly
hit 20 bps last month, the widest in almost five months.
As this graphic, reut.rs/2h03Dn5 shows, a widening in
the spread -- a gauge of how investors view relative risk --
since the U.S. election has been modest compared with the move
in French or Italian bonds.
"If the Dutch/German 10-year spread got out to 30 bps that
would be a good time to get back in, but if it broke below 10
bps, you'd have to say it's not pricing in enough of a risk,"
said ING global head of debt and rates strategy Padhraic Garvey.
Analysts do not expect Wilders, who has lived with 24-hour
protection for a decade because of anti-Islam comments, to
become the next prime minister because other large and
medium-sized parties have said they are unwilling to work with
the Freedom Party or support Nexit.
Even if the Freedom Party secured a place in government, a
majority in the Netherlands in favour of leaving the EU remains
unlikely and that should limit any impact on the country's
borrowing costs, says Dutch bank ABN AMRO.
Also, any worries about a Nexit that could raise euro zone
break-up risks may be more evident in the selling of weaker,
peripheral countries such as Italy and Portugal or in greater
demand for top-rated German debt.
And if this month's Italian referendum is any guide, bond
markets should recover from any short-term turbulence.
Like Germany, the Netherlands has a rare triple-A credit
rating -- allowing it borrow more cheaply than lower-rated peers
such as Italy.
As a "core" euro zone bond market, Dutch bonds tend to be
less volatile, backed by a relatively robust economy.
Strengthening economic growth could also dent Wilders' standing
in the polls in the months ahead.
Debt of all countries with rising populist parties and
increased risks has underperformed in recent weeks, however, and
Dutch bonds are unlikely to be immune from concerns about the
political outlook as the election nears, analysts said.
Michael Krautzberger, BlackRock's head of European fixed
income, said the firm had gone underweight Dutch bonds, partly
because of election uncertainty but mostly because Dutch bonds
were very expensive on a valuation basis.
"In some markets like France and Italy you also have
uncertainty but markets are fully priced to reflect that. To
some degree that is absent in the Netherlands," he said.
(Reporting by Dhara Ranasinghe; Graphic by Nigel Stephenson;
Editing by Catherine Evans)