Euro zone yields fall amid demand for safe-haven assets



* Talks over Ukraine started on Friday in Switzerland

* Bund yields hit one-week low

By Stefano Rebaudo

Jan 21 (Reuters) - Euro zone government bond yields fell on Friday amid mixed signals from the European Central Bank and increased demand for safe-haven assets as geopolitical worries over Ukraine mounted while equity markets fell.

The top U.S. and Russian diplomats made no major breakthrough at talks on Friday but agreed to keep talking to try to resolve the Ukraine crisis that has stoked fears of a military conflict.

Accounts of last month's ECB meeting published on Thursday showed policymakers had argued that euro zone inflation could "easily" get stuck above target and the central bank should keep the door open to tightening policy.

On Friday, however, ECB President Christine Lagarde said euro zone wage demands remained modest enough to support expectations for inflation to decline this year.

"With little sign of de-escalation surrounding the Russia-Ukraine tensions, the demand for safe havens keeps the upper hand for now," ING analysts said.

German 10-year government bond yields were down 5 basis points at 1528 GMT after hitting a one-week low of -0.087% earlier in the session in their biggest drop since Nov. 26.

10-year Bund yields rose above zero on Wednesday, hitting the highest level since May 2019 of 0.025%.

"Bond bears are facing a tougher time as already ambitious rate hike expectations align with negative carry," Commerzbank analysts said.

Money markets have priced an about 80% chance of the ECB raising rates by 10 bps in September and 10 bps again in December 2022.

"We believe the ECB is very unlikely to raise rates in 2022, and we think money markets are just buying a sort of insurance policy against inflation risks when they price in two 10 bps rate hikes in 2022," Fabio Castaldi, senior investment manager at Pictet Asset Management, said.

Investors were wary ahead of the Federal Reserves' policy meeting next week as Fed officials, having plotted a plan to battle high inflation, must now contend with new signs the coronavirus is again slowing the economy.

ITALY'S PRESIDENTIAL VOTE

Italian government bond yields fell 3 bps to 1.34%, with the spread between Italian and German 10-year yields at 141 basis points. IT10YT=RR DE10IT10=RR

Analysts have warned about a potential increase in Italy's risk premium if former ECB chief Mario Draghi became Italian president in a vote next week. Confidence in Italy's debt-ridden economy improved when he became prime minister in February 2021.

Pictet's Castaldi said, however, that if "the current government remains in office with a strong parliamentary support and completes the necessary reforms to access the European funds," the yield spread with Germany might tighten even if Draghi did leave his current role to became president.

"I don't see the spread tightening over 120 basis points shortly as the ECB is tapering its monetary stimulus," he said.

Markets at the moment don't see snap elections as a likely outcome even if Draghi were to change jobs but in a more uncertain scenario some analysts see the Italian-German spread widening up to at least 150 bps.



IT-DE yeild spread Link



Reporting by Stefano Rebaudo; Editing by David Clarke and
Tomasz Janowski

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