* Germany economy contracts in Q2
* Bund yield hits new record low
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr
By Dhara Ranasinghe
LONDON, Aug 14 (Reuters) - Government borrowing costs in Germany fell to fresh record lows on Wednesday after news that the economy shrank in the second quarter reinforced expectations for monetary policy stimulus soon.
Germany’s gross domestic product fell 0.1% quarter on quarter after growing 0.4% in the first three months of the year, the latest sign that Europe’s biggest economy is taking a knock from world trade disputes.
The 10-year German bond yield dipped to -0.624%, a fresh record low that takes its fall this year to almost 90 basis points.
Across the euro zone, most long-dated bond yields were a touch lower on the day.
While news on Tuesday that Washington has delayed tariffs on some Chinese imports sparked a surge in world stock markets, demand for fixed income remained strong.
Analysts put that down to a weak economic backdrop as well as rising risks ranging from Brexit to turmoil in Hong Kong, a rout in Argentina’s financial markets and political uncertainty in Italy.
“There is a lot of pessimism pervading in the euro zone bond market and that reflects the easing that’s expected from the ECB (European Central Bank),” said Antoine Bouvet, senior rates strategist at ING in London.
“This also helps explain why the bond market hasn’t really reacted significantly to the headlines on trade.”
In a further sign of growing concern about recession risks, the gap between U.S. 2-year and 10-year note yields on Tuesday fell to just 0.6 basis points — the narrowest since June 2007.
The spread is a closely watched metric for recession signals. The last time this yield curve inverted was in June 2007 in the midst of the U.S. sub-prime mortgage crisis.
“The 2-year, 10-year (spread) is our favourite recession indicator and as it flirts with inversion we’ve become more concerned about the downside risks,” Deutsche Bank analysts said in a note.
Elsewhere, Italian bond yields fell for a third straight session as Italy’s Senate slowed a government crisis.
The Senate on Tuesday postponed till next week further debate on an ongoing government crisis, frustrating a push by Matteo Salvini, leader of the far-right League party, for new elections.
Italy’s 10-year bond yield fell 5 bps to 1.57%, narrowing the gap over safer German Bund yields to 219 bps — down from five-week highs hit Friday at 239 bps.
Reporting by Dhara Ranasinghe; editing by Jason Neely