February 9, 2017 / 12:57 PM / a year ago

UPDATE 2-Bashed French bonds bounce back, yields fall to 2-week low

* Battered French bond yields fall to 2-week low

* Other euro zone yields pull back from multi-month highs

* Analysts cite a covering of short positions

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Dhara Ranasinghe

LONDON, Feb 9 (Reuters) - France’s benchmark borrowing costs fell back below 1 percent for the first time in two weeks on Thursday, as fears about the political risks it faces gave way to a sense that recent selling of French debt had gone too far.

Investor nerves jarred by the strong showing of far-right leader Marine Le Pen’s ahead of this spring’s presidential election helped send the spread between French bond yields over German ones to multi-year highs this week.

As French bonds recovered ground on Thursday so did other euro zone bonds that have suffered from heightened political risks and worries about an unwinding of European Central Bank stimulus.

Analysts said a build-up of short positions on French bonds - essentially a bet that their value will decrease - had reached a point that further negative news was needed to justify more selling.

“We’re in an environment where political risk is pretty much at the forefront and we’re not going to get any decisive news on that for a number of days,” said Orlando Green, European fixed income strategist at Credit Agricole.

“There is an element of people closing out of their positions and pausing for thought.”

In addition, the view that the ECB is unlikely to unwind its bond-buying stimulus in an environment in which political risks remain elevated may have helped a recovery in euro zone bonds generally, analysts said.

ECB President Mario Draghi said this week that no policy tightening was coming as growth was still weak and faced risks. He meets German Chancellor Angela Merkel later on Thursday.

France’s 10-year bond yield fell 4 basis points to a two-week low of 0.96 percent, pulling the gap over top-rated German peers down from four-year highs.

The moves in French bond yields this week have been eye-catching.

On Monday, they soared to near 17-month highs at 1.16 percent as investors fretted about the most unpredictable presidential election race in decades in the euro zone’s second biggest economy.

But that move started to unwind on Thursday and yields fell almost 11 bps -- the biggest one-day fall since December 2015.

Most other euro zone bond yields were down 1-6 bps.

Italian and Spanish bond yields fell about 5 bps each, with Italian yields hitting a two-week low at 2.17 percent .

In Germany, 10-year bond yields pulled away from Wednesday’s 2-1/2 week lows as demand for safe-haven German debt ebbed.

Analysts said renewed worries about Greece were also exacerbating investor jitters over euro zone stability.

Two-year Greek bond yields rose to around 10.09 percent , their highest level since June last year.

Greece’s bailout programme is being held up by a dispute over the country’s fiscal targets. The International Monetary Fund argues that a primary fiscal surplus target of 3.5 percent of gross domestic product cannot be met without massive debt relief or further austerity measures that would hurt growth.

Germany, which faces national elections in September, opposes any discussion of debt relief before Greece reaches the bailout target.

“Tapering concerns and political risks have been the main drivers of bond spreads in the euro zone, worries about Greece could become the third pillar of that move,” said Martin Van Vliet, senior rates strategist at ING.

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 Larry King and John Stonestreet)

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