Improved economic outlook sends Bund yields to seven-week highs
* Bets euro zone economy improving hurt low-risk bonds
* German yield curve steepens as ECB anchors short end
* Italian, Spanish risk premia at two-year lows
LONDON, Aug 13 (Reuters) - Ten-year Bund yields hit their highest for seven weeks on Tuesday after a forecast-beating German business morale survey cemented expectations the euro zone was crawling out of a long recession. The ZEW index for August came in at 42.0, beating a 40.0 consensus forecast and helping reduce the risk premia on bonds issued by Spain and Italy, where subdued growth prospects have been a credit concern throughout the euro zone crisis. The yield premium offered by both Italian and Spanish 10-year debt over benchmark German Bunds hit new two-year lows. "Looking forward to the second half of the year, I think the recent improvement suggests that we could see ... maybe slightly positive growth momentum," said Anders Svendsen, chief analyst at Nordea in Copenhagen. Data due on Wednesday is expected to show the currency bloc's economy grew 0.2 percent in the second quarter. Ten-year German yields hit their highest since June 26 at 1.78 percent, while Bund futures fell almost a point to as low as 141.24 - their biggest fall in three weeks. Yields hit 2013 highs of 1.85 percent in June after the Federal Reserve said it planned to curb monetary stimulus if economic data remained strong. Yields have since dropped after the European Central Bank promised to keep interest rates at record lows for a prolonged period or even cut them further - a pledge which is steepening the German yield curve. Two-year German yields rose 2.5 bps to 0.19 percent, while five-year yields rose 6.6 bps to 0.74 percent. "The long end is being pushed higher both by improving domestic fundamentals in Europe and the Fed outlook," said Sanjay Joshi, head of fixed income at London and Capital. Recent economic data has not been strong enough to raise expectations that the ECB may soon begin to consider tighter policy though further easing is being priced out. Euribor short-term interest rate futures for 2013 to 2016 fell, indicating three-month Euribor interbank rates were seen higher, suggesting fading chances of a rate cut. "Does the stronger data make a rate cut less likely? I guess it does to some extent, but ... the discussion really has to come about after the political risk has passed in September with the German elections," said Simon Peck, rate strategist at RBS. The election is seen as a major hurdle for the bloc as key political decisions have been postponed until after the vote.
TIGHTER SPREADS The improved economic outlook has not hurt bonds in Italy and Spain, where growth is crucial to tackle ballooning public debt. The gap between Italian and German 10-year yields narrowed by 6 bps to 240 bps, the lowest since early July 2011, and the equivalent Spanish spread tightened by 8 bps to 270 bps, the lowest since August 2011. Also helped by the reduced supply pressure after Italy and Spain cancelled mid-August debt sales and by the ECB's conditional promise to buy government bonds if needed, the spreads could tighten further in coming weeks, analysts said. "The recent weeks of action suggest that we could see quite significant spread compression if we continue to see remarkably good growth and a fairly dovish ECB," Nordea's Svendsen said. Credit Suisse strategists recommend taking profits at 200 bps in the Italian spread and when Spain's hits 230 bps.