UPDATE 1-Safe-haven German Bund yield falls to three-week lows on US-Iran tension

Dhara Ranasinghe


* German Bund yield falls to -0.31%

* U.S.-Iran tensions dominate

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates move in Bund yield, adds chart, comment)

LONDON, Jan 6 (Reuters) - Germany's safe-haven 10-year bond yield dropped to its lowest in over three weeks on Monday, as tension between the United States and Iran remained high after the killing of a top Iranian general by a U.S. drone strike in Iraq last week.

Iraq's parliament called on Sunday for U.S. and other foreign troops to leave as a backlash grew against Friday's killing of Iranian general Qassem Soleimani. U.S. President Donald Trump renewed threats to target Iranian cultural sites if Tehran retaliates.

The attack left U.S.-Iranian hostilities in uncharted waters, rattling world markets just as an easing in U.S.-China trade tensions along with better economic data had boosted investor sentiment.

That in turn has pushed yields on euro zone government bond down from multi-month highs reached just before Friday's U.S. air strike.

The yield on Germany's benchmark 10-year bond, a safe haven that usually gains during global uncertainty or risk, briefly fell to -0.31% -- its lowest in over three weeks.

Yields later pulled back to -0.29%, flat on the day, but remained around 15 basis points below Thursday's seven-month highs.

The German bond yield curve, measured by the gap between 10 and two-year bond yields, was near its flattest in three weeks .

"The bond market has picked up and there has been bull flattening in the curve," said Henry Occleston, rates strategist at Mizuho in London.

"The question now is how long is this situation going to last and will the tensions escalate? Right now, it appears it's not going to go away quickly."

Across the euro zone, most 10-year bond yields were lower on the day , having touched their lowest levels in around three weeks. U.S. Treasury yields were steady near one-month lows.

Analysts said geopolitical tensions were likely to overshadow prospects for better economic growth for now, keeping bond yields down.

That backdrop should also help markets absorb new bond supply this week, when Austria, Germany, France and Spain will hold debt auctions.

"We think the shock to confidence and potential for a drop in consumption are more pressing concerns for investors, the (yield) curve should thus remain flat until and unless tensions ease," said Antoine Bouvet, senior rates strategist at ING, referring to the unexpected rise in geopolitical tensions.

In Spain, Socialist leader Pedro Sanchez failed on Sunday in a first attempt to get parliament's backing to form a government. That had been anticipated in bond markets, analysts said, and Spain's 10-year bond yield was steady at 0.39%

Sanchez is expected to succeed in a second vote on Tuesday, when only a simple majority is needed, after securing a commitment from Catalonia's largest separatist party, Esquerra Republicana de Catalunya, to abstain.

(Reporting by Dhara Ranasinghe, editing by Larry King)