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Ukraine tension sends German yields to near 3-week lows

Emelia Sithole-Matarise and Marius Zaharia
Wednesday, 26 Feb 2014 | 12:08 PM ET

* German 10-year yields at lowest in nearly 3 weeks

* Russian troops on alert in drill near Ukraine border

* Geopolitical concerns overshadow poor German auction

* Investors wary of pushing yields up as ECB eyed

(Recasts with rally in Bunds, fresh comments, detail)

LONDON, Feb 26 (Reuters) - German government bond yields fell to their lowest in nearly three weeks on Wednesday as mounting geopolitical tensions over Ukraine spurred flows into low-risk debt.

Russia ordered an urgent drill to test the combat readiness of its armed forces near Ukraine, in a sign of sabre rattling after its ally Viktor Yanukovich was toppled as president in Kiev.

These developments overshadowed a poorly received second consecutive German debt sale and drove German 10-year yields 4 basis points down to 1.62 percent. Bund futures jumped 49 ticks to settle at 144.46, having traded slightly lower for most of the day.

"The market is being driven by geopolitical tensions with the unrest in Ukraine and the reports of Russian troops being put on alert," said Gianluca Ziglio, head of fixed income research at Sunrise Brokers.

"Emerging market turmoil is not completely removed and the unrest in Ukraine is creating a situation where there's not enough conviction for people to short Bunds."

Earlier, Bund yields had traded in a tight 1.64-1.66 percent range after investors shunned a 30-year debt sale in Berlin, suggesting they saw scant value in the "painfully" low returns on offer.

The sale attracted bids worth less than the maximum 3 billion euro target, making it the second so-called "technically uncovered" auction in a row after a 10-year debt sale last week.

Demand suffered due to the low returns, analysts said - one described the roughly 2.5 percent ultra-long yield, which compares with a medium-term European Central Bank (ECB)inflation target of just below 2 percent, as "terrible".

But post-auction market reaction was limited, suggesting investors were not convinced yields should be much higher either. Many see no prospect that either growth or inflation will pick up in the foreseeable future.

Yields on 30-year Bunds were 5.5 bps down at 2.48 percent in late trade, just 4 bps above a 2014 low of 2.44 percent with the move lower accelerating on the news from Ukraine and Russia.

"PAIN TRADE"

Expectations the ECB will ease monetary policy further to avoid growth-crippling deflation are also growing. Such a move would push yields lower.

"With Bund yields where they are, there isn't too much conviction in the Bund rally going forward," said Michael Leister, rate strategist at Commerzbank. "On the other hand, investors want to go short but they feel it is a bit difficult, especially with the ECB meeting (scheduled) next week."

At the end of last year, most analysts predicted 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 just over 30 bps less than at the end of December, driven down by record low inflation and as tensions in some emerging markets channel investment flows into low-risk assets.

"(The Bund) is absolutely a pain trade and will continue to be a pain trade until the central bank will give you the signal to sell the short end," said RBS strategist Harvinder Sian, referring to any signal that the ECB was about to tighten monetary policy and push short-term interest rates higher.

(Editing by Susan Fenton)