* U.S. yield curve inverts for first time since 2007
* German yield curve flattest since 2008
* Germany economy contracts in second quarter
* Bund yield hits record low
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates pricing)
By Dhara Ranasinghe and Virginia Furness
LONDON, Aug 14 (Reuters) - Government borrowing costs in Germany fell to record lows on Wednesday as global recession fears grew, with the U.S. Treasury yield curve inverting for the first time since 2007 and Germany reporting that its economy had shrunk in the second quarter.
Euro zone government bond yields extended earlier declines after the two- to 10-year Treasury yield curve inverted, a sign that investors are bracing for recession risks in the United States.
The yield curve is closely watched for recession signals. The last time it inverted was during the U.S. sub-prime-mortgage crunch that set off the global financial crisis.
“What this means is that markets are signalling that central banks are running out of options ... It points to a bigger, broader picture of major industrial economies such as China and Germany haemorrhaging growth,” said Stephen Gallo, European head of FX strategy at BMO Markets.
Yield curves across Europe flattened as the curve between Germany’s two- and 10-year bonds shrank to 21 basis points, the narrowest since 2008. In Britain shorter-dated borrowing costs fell below 10-year gilt yields for the first time since 2008.
Germany’s gross domestic product fell 0.1% quarter-on- quarter after growing 0.4% in the first quarter, the latest sign that world trade disputes are damaging Europe’s biggest economy.
The 10-year German bond yield fell to -0.656%, a record low that takes its decline this year to almost 90 basis points. Its 30-year bond yield also hit a record low at -0.195% .
Across the euro zone, most long-dated bond yields were down by as much as 10 basis points, in many cases hitting new all-time lows. .
“The drop in the ultra-long end was swap-driven last week, but now it is changing to the cash market, which shows there is a more fundamental driver to (the move lower in) long dated bond yields,” said Rainer Guntermann, rates strategist at Commerzbank.
News on Tuesday that Washington would delay tariffs on some Chinese imports sparked a surge in world stock markets, but demand for fixed income also remained strong.
Analysts put that down to a weakening global economy as well as 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.”
Elsewhere, Italian bond yields fell for a third straight session as Italy’s Senate slowed a government crisis.
The Senate on Tuesday postponed until next week debate on the country’s 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 over bps to 1.51% , narrowing the gap over safer German Bund yields to 215 bps — down from Friday’s five-week high of 239 bps.
Reporting by Dhara Ranasinghe and Virginia Furness; additional reporting by Saikat Chatterjee; editing by Gareth Jones