LONDON Investor uncertainty about France's presidential election took its toll on French bonds on Monday, pushing up the premium investors demand for holding French over German government bonds to its highest in almost four years.
The move came after far-right National Front leader Marine Le Pen launched her presidential bid, vowing to fight globalisation and take France out of the euro zone.
French 10-year bond yields hit 17-month highs while nervous investors pushed yields on top-rated German bonds to their lowest level in almost two weeks and dumped riskier, lower-rated debt in southern Europe.
German bonds, perceived as one of the safest assets in the world, also benefited from U.S. political risks and uncertainty about the timing of the next U.S. interest rate hike after Friday's jobs report pointed to tepid wage growth.
Buoyed by the election of President Donald Trump in the United States and by Britons' vote to leave the European Union, Le Pen's anti-immigration, anti-EU party is seeking to tap into similar voter dissatisfaction in France.
Le Pen laid out her presidential election manifesto at the weekend, pledging to curb migration drastically, take France out of the euro zone and hold a referendum on EU membership.
France would default on its sovereign debt if it unilaterally converted its euro-denominated obligations into new francs following a Le Pen victory, a senior executive at ratings agency Standard & Poor's told The Economist.
Le Pen's strong showing in opinion polls has rattled investors at a time when conservative Francois Fillon, once the favourite to win presidential elections in April and May, is embroiled in a scandal over salary payments to his wife. Rising centrist star Emmanuel Macron, meanwhile, is as yet untested.
Fillon will hold a news conference at 1500 GMT on Monday, a source close to him said.
"Le Pen winning is unlikely, but the situation in France is certainly raising fears among investors," said DZ Bank rates strategist Christian Lenk. "French bonds will continue to underperform even though a lot is priced into the market."
France's 10-year bond yield rose as much as 4 basis points to about 1.14 percent FR10YT=TWEB, its highest level in about 17 months. In contrast, Germany's 10-year Bund yield tumbled 5 bps to 0.36 percent DE10YT=TWEB.
Deutsche Bank said the risk for markets is in the first round of voting.
Both Fillon and Macron are expected to win if they go head to head with Le Pen in the second round, but the outcome is uncertain if Socialist party candidate Benoit Hamon makes it through and faces Le Pen.
Polls suggest Le Pen will win enough votes to go through to the second round of voting, but the overall margin between Fillon, Macron and Hamon is just 5 percent.
As German and French bond yields pulled in different directions, the gap between the two briefly pushed out to 73 basis points - its widest level in almost four years.
The French political jitters rippled across the euro zone, prompting investors to sell lower-rated bonds.
Italy's 10-year bond yield hit a 19-month high at 2.37 percent IT10YT=TWEB, with the gap over German peers hitting 200 bps. The Portuguese spread was at its widest in three years.
"The Italian spread over Germany is now 200 bps, which is quite an inflection point," said Commerzbank rates strategist Christoph Rieger. "Le Pen's comments at the weekend have not brought new news, but highlight the tail risks from France right now."
There was little immediate reaction to comments from European Central Bank president Mario Draghi, who reiterated that underlying inflation pressures remain subdued.
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(Editing by Catherine Evans)