* German 2,5-year yields hit 1-1/2 week highs
* ECB report, ECB comments, easing geopolitical worries weigh
* ECB’s Coeure: Prospects for economy have improved (Updates throughout)
By Dhara Ranasinghe and Abhinav Ramnarayan
LONDON, April 19 (Reuters) - Shorter-dated German government bond yields shot higher on Wednesday following an ECB report on market financing conditions and comments from central bank policy makers.
Analysts also cited a recovery in risk sentiment, reflected by firmer stocks, and an easing of geopolitical concerns as factors behind the rise in two- and five-year German yields to 1-1/2 week highs.
Two-year bond yields jumped almost 6 basis points to minus 0.79 percent and were set for their biggest one-day rise since the start of March.
In a survey of banks released on Wednesday, the European Central Bank said the liquidity and functioning of markets for underlying collateral, especially in government bonds, has deteriorated.
The scarcity of high-quality short-term debt, which is used as collateral in funding markets, has helped drive yields on the bonds lower.
Commerzbank strategist David Schnautz said the bank survey could encourage the ECB to take action to address a shortage of bonds for use as collateral.
“So far the ECB’s mantra has been that markets are functioning normally, so it seems to be softening its stance by acknowledging the knock-on effects of QE to the proper functioning of the market,” Schnautz said.
Shorter-dated bonds led selling across the German curve, with five-year bond yields up 5 bps at a 1-1/2 week high of minus 0.47 percent.
Comments from a string of ECB policymakers added to selling pressure in bond markets, analysts said.
Prospects for the euro zone economy have improved and the risk of a new downturn is no longer prevalent, ECB director Benoit Coeure said, expressing a more benign view than ECB chief Mario Draghi.
Earlier, ECB governing council member and Estonian central bank chief Ardo Hansson said the central bank still needs more hard economic data before considering any specific change in policy.
“Maybe the market has decided this is the start of a tapering discussion and most recently it’s been (German) Bunds that have been profiting from QE, especially the short end,” said DZ Bank strategist Christian Lenk.
He said a somewhat underwhelming auction of long-dated German bonds may have also weighed on the German curve.
Germany, the euro zone’s benchmark issuer, sold 814 million euros in a top-up of its bonds maturing in 2044, generating demand of 1.012 billion euros for the sale.
Stability in opinion polls ahead of a first round of voting in French presidential elections on Sunday helped push the France/Germany 10-year government bond yield spread below 70 basis points for the first time in over a week.
France’s 10-year bond yield briefly fell to 0.86 percent , its lowest level in almost three months.
“The market is calming down a little because of stability in the polls with (Emmanuel) Macron continuing to be in the lead. I think it still looks quite likely we will see a head-to-head between (Marine) Le Pen and Macron in the second round,” said Lenk.
The gap between French and German borrowing costs had widened in recent weeks on concerns that far-right leader Le Pen might take power and try to lead France out of the euro.
The latest poll shows Macron winning the first round on April 23 and beating Le Pen in the run-off vote on May 7.
South European bond yields, which tend to be sensitive to concerns over the future of the euro zone, fell. Portuguese yields hit a three-week low of 3.78 percent. (Editing by Mark Trevelyan)