* Pool of negative-yielding bond yields shrinking
* German five-year yields positive for first time since 2015
* German bond curve positive in two years, forwards show
LONDON, Jan 29 (Reuters) - Slowly but surely, the pool of euro-area government bonds with sub-zero yields is shrinking, a sign that some normality is returning to bond markets as central banks begin to unwind their extraordinary stimulus.
Five-year bond yields in Germany, the bloc's powerhouse economy and its benchmark debt issuer, rose above zero percent on Monday for the first time since late 2015.
That marks a significant shift from two years ago, when massive monetary easing and record low interest rates in the wake of the financial crisis pushed bond yields to record lows -- and below zero percent -- in much of the developed world. Then, up to $13 trillion worth of debt globally was trading with yields of less than zero.
But with the European Central Bank heading to the exit on quantitative easing (QE), economic recovery clearly underway and inflation expectations rising, investors are increasingly unwilling to effectively pay to lend to governments.
A year ago, German bonds of maturities out to seven years had negative yields. In 2016 even 15-year bonds carried sub-zero yields, as concerns about deflation and weak growth weighed on markets, along with hefty ECB stimulus.
Two-year bond yields remain in negative territory at minus 0.52 percent, but are at their highest since mid-2016.
"We talk about negative interest rates but it's only a negative 50 basis points. Think about it, we are going through a year where the ECB goes from being a net buyer of government bonds to no longer doing that," said Doug Peebles, CIO for fixed income at Alliance Bernstein in New York.
"Our base case is that the ECB raises rates in Q1 2019, so we could easily get to a positive level on the German two-year bond yield by the end of the year."
According to Deutsche Bank, 2018 will be the first year this decade that assets purchased under QE from the ECB, the U.S. Federal Reserve and the Bank of Japan will not increase relative to net government bond sales from these three regions.
"How bonds cope with this will be one of the key drivers of assets in 2018," the bank said in a note.
The move away from sub-zero yields will be welcomed by investors and policymakers alike.
For conservative investors such as pension funds, negative long-term yields have hammered the returns they can get from "safe" assets such as German government bonds.
They are also potentially damaging for banks' balance sheets and net interest margins, as well as a headache for policymakers trying to build confidence in the economic recovery and prevent deflationary expectations from becoming embedded.
Tradeweb data shows that about 42 percent of the 7 trillion euros worth of euro zone government bonds trading on its platforms still carry yields below zero. But that is down from a peak of 52 percent in July 2016.
"Many investors will want to see a sustained move into positive territory before breaking out the champagne," said Andy Cossor, rates strategist at DZ Bank.
The process of the ECB "normalizing" its monetary policy remains in its infancy. The bank will buy bonds at least until the end of September, suggesting that support for low borrowing costs will remain in place for some time.
The euro zone's central bank is also expected to re-invest proceeds from maturing bonds it holds this year, limiting how far bond yields rise.
However, recognition that the global environment is very different to two years ago when negative-yielding bond volumes peaked, means the tide is shifting.
At the end of last year, just under $10 trillion worth of bonds traded with negative yields globally, Fitch Ratings estimates, more than $3 trillion below the peak.
Mark Dowding, a portfolio manager at BlueBay Asset Management, said bond forwards are already pricing in positive short-dated German bond yields of near 20 bps in two years' time. That is a clear indication that markets believe no European bonds will be trading with sub-zero yields by then.
Short-dated bond yields in France and Italy are just 2-4 basis points away from turning positive. "You could almost say that in the course of over 12 months, the pool of bonds with a negative yield is likely to shrink in half," Dowding said.
(Reporting and graphics by Dhara Ranasinghe; Editing by Catherine Evans)