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German yields dip before bond sale offering "terrible" returns

LONDON, Feb 26 (Reuters) - German government bond yields dipped on Wednesday before a 30-year auction offering returns that suggest investors expect neither growth nor inflation will pick up in the foreseeable future.

The auction will be closely watched as it follows a 10-year Bund sale last week that drew bids worth less than the maximum amount on offer. Some analysts said it showed investors were uncomfortable with the low returns in Germany.

However the result did not lead to higher secondary market yields, suggesting investors doubted euro zone policymakers can act swiftly to avoid growth-crippling deflation.

At roughly 2.5 percent, the ultra-long 30-year German yield is only slightly above the European Central Bank's medium-term inflation target of just below 2 percent.

"The 30-year yield basically tells you that investors are not fearing any increase in inflation or a big pick-up in nominal growth," DZ Bank strategist Christian Lenk said.

"It does a little bit sound like Japan, although it's not comparable yet at these levels."

Germany aims to sell up to 3 billion euros of new 30-year bonds in an auction that closes at roughly 1030 GMT.

Most analysts forecast at the end of last year that German yields would rise in 2014, tracking their U.S. counterparts as the Federal Reserve gradually reduces its bond-buying stimulus programme and the euro zone economy recovers.

However, benchmark 10-year Bunds yield 30 basis points less than at the end of December, as low inflation fuels expectations the ECB will ease policy later this year and tensions in some emerging markets channel investment flows into low-risk assets.

Ultra-long paper is less sensitive to the ECB outlook than short-dated bonds and more dependent on global growth prospects, which are improving and driving the Fed policy shift. For some analysts, this should see 30-year bonds underperform the 10-year, with the yield gap between them widening, leading to a steeper yield curve.

"This may be a challenging auction," Societe Generale strategists said in a note. "The good news is that the 10/30 year slope has steepened this year, which may tempt some investors. The bad news is that we look for more steepening as the ECB is under pressure to deliver more easing while the Fed walks to the exit."

RANGE-BOUND

Thirty-year German yields fell 1 bps to 2.52 percent, while 10-year yields were flat at 1.65 percent. The 87 bps gap between them is comfortably within this year's 84-93 bps range.

Some analysts say the auction might find sufficient demand from investors with specific interest in longer-term debt, such as pension funds and insurers.

"Yields look optically terrible... but the long-end of the curve is a black magic region," Rabobank rate strategist Lyn Graham-Taylor said.

"You have natural buyers in pension funds looking to match assets and liabilities. It's only up to 10-years where you can say (the curve) reflects normal economic (expectations)."

Portuguese five-year yields hit a 3-1/2 year low of 3.744 percent as investors welcomed Lisbon's plans to buy back short-term debt on Thursday to ease its immediate financing needs. The buyback of 2014 and 2015 bonds is seen as a further step towards exiting an international bailout.