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UPDATE 1-French-German bond yield spread returns to pre-crisis levels

* France's borrowing costs just 17 bps away from German levels

* German elections no concern for bond investors, analysts say

* Lower-rated euro zone bonds outperform on economic optimism

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Writes through)

LONDON, Nov 21 (Reuters) - The gap between French and German borrowing costs moved to its tightest level since before the euro zone debt crisis of 2010-2012, as growing optimism over the future of the bloc overwhelms concerns over the political stalemate in Germany.

With major supply out of the way, European Central Bank largesse continuing to flow and with no major headline risks for the rest of the year, the market has no reason to bet against the euro zone at the moment, one analyst said.

As a result, lower-rated euro zone government debt is continuing its recent outperformance, with spreads tighter across the bloc.

"All those shorting France have slowly been squeezed out and no-one is willing to take the opposite position now, with no obvious risks looming and with supply winding down," said ING strategist Benjamin Schroeder.

Even the prospect of a prolonged political stalemate in Germany has left bond investors unmoved, he said.

"We've had lots of experience with caretaker governments being in place for some time in Europe. Belgium and Netherlands didn't fare too badly, in fact they did quite well (without a government) and the economic backdrop of Germany looks very decent," he said.

Indeed, the German economy looks set to power into the year end despite the government impasse, the country's central bank said this week.

Given this, France's 10-year government bond yield spread over Germany narrowed to 17 basis points on Tuesday morning, a level last seen in August 2009, well before a series of sovereign debt crises hit the single currency bloc.

Those crises -- which culminated in bailouts for Greece, Cyprus, Portugal and Spain and ultimately led to the ECB's multi-trillion euro bond-buying scheme -- had jolted investors into assigning different risks to different euro zone countries.

Borrowing costs within the bloc diverged sharply in the years that followed. At one point in November 2011, the 10-year bond yield spread between France and Germany was 191 bps and the Italy-Germany spread was a whopping 536 bps.

Those spreads narrowed after ECB chief Mario Draghi famously said the bank would do "whatever it takes" to save the single currency, quelling bets on the collapse of the euro zone.

The bank's continued support of the market, most recently with an extension of its bond-buying scheme until September 2018 at the very least, is driving spreads tighter.

On Tuesday, the premium investors demand to hold Italian debt over German was at 143 bps, close to a one-year low hit earlier this month.

Other Southern European bond yields also fell 2-3 bps on Tuesday, as investors continue to take advantage of the higher yields they offer in a benign environment.

(Reporting by Abhinav Ramnarayan, Editing by Karin Strohecker and Catherine Evans)