November 17, 2017 / 11:53 AM / a year ago

UPDATE 2-German Bund yields set for biggest weekly fall since ECB meeting

* Draghi: Cheap ECB cash still key for euro zone

* Bund yields set for biggest weekly fall since Oct ECB

* US yield curve close to flattest in 10 years

* Euro zone periphery govt bond yields (Updates prices)

By Dhara Ranasinghe

LONDON, Nov 17 (Reuters) - Borrowing costs in Germany were set on Friday for their biggest weekly fall since the European Central Bank’s meeting three weeks ago sparked a rally across euro zone bond markets.

After a sell-off at the tail end of last week, buying of euro zone bonds has resumed this week, with safe-haven German debt boosted by sales of risk assets and a fall in oil prices, which has weighed on inflation expectations.

Oil prices were set for their first weekly decline in six weeks, under pressure from surging U.S. supplies and doubts over Russian support for continuing a cut in crude output. Brent crude oil prices have fallen over 2 percent this week .

German 10-year Bund yields were a basis point lower on Friday at around 0.365 percent, in line with euro zone peers.

They have fallen almost 6 basis points this week, the biggest weekly drop since Oct. 26, when the ECB extended its asset-purchase scheme into 2018, albeit at a reduced pace, cheering bond markets where the bank’s ultra-loose monetary policy has held down borrowing costs.

“Yields have moved to the downside again this week driven by some investors taking the opportunity to buy bonds after the sell-off last week,” said DZ Bank rates strategist Daniel Lenz. “The significant drop in oil prices has also played a role since that has lowered inflation expectations.”

The five-year, five-year breakeven inflation forward, a gauge of long-term inflation expectations in the euro area that the ECB follows, has pulled back from eight-month highs hit earlier this week just above 1.7 percent.

The euro zone economy still depends on cheap credit, and the ECB is using the extension of its bond buying to push out any expectation for a rise in borrowing costs, ECB President Mario Draghi said on Friday.

“It’s hard to see higher yields until you get a more hawkish impetus from the ECB, and we’re not going to get that for a little while yet,” said Seamus Mac Gorain, fixed income portfolio manager at JPMorgan Asset Management.

In Germany, Chancellor Angela Merkel’s efforts to forge a three-way ruling coalition might last all weekend after the parties missed Merkel’s Thursday deadline and failed to reach agreement on key issues such as migration and finances .

The news appeared to have little effect on the bond market.

Two-year U.S. Treasury yields hit a nine-year high with the Federal Reserve seen on track to raise interest rates in 2018. The rise in two-year yields has pushed the bond yield curve to its flattest in a decade.

Reporting by Dhara Ranasinghe; Editing by Larry King and Mark Potter

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