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German bond yields set for first weekly fall since May on growth fears

By Yoruk Bahceli and Samuel Indyk

June 24 (Reuters) - Safe-haven German bond yields were set for their first weekly fall since mid-May on Friday after growth fears gripped markets, though they reversed some of the drop after a German business sentiment survey indicated a recession was not yet in sight.

Prior to this week, yields had risen sharply in the face of red-hot inflation and aggressive central bank rate hikes.

But the U.S. Federal Reserve chairman committing to curbing inflation even at the risk of a growth downturn, a sharp slowdown in business activity growth and Germany triggering the alarm stage of its emergency gas plans have put growth fears in the spotlight this week.

Germany's 10-year yield, the benchmark safe asset for the euro area, has fallen 20 basis points (bps) this week, the first weekly fall since mid-May.

Two- and five-year yields, particularly sensitive to policy expectations, have fallen even more, by 26 and 29 bps respectively.

"The combination of earlier than expected signs of slowdown in the services sector, coupled with concerns (over) energy supplies, raises the risk of the ECB having to deal with a stagflationary situation where inflation expectations keep on being high and the growth outlook being weak," said Danske Bank chief analyst Piet Christiansen.

Given the scale of the bond market rally, euro investment-grade corporate bonds also delivered their biggest daily return since March on Thursday, according to ICE BofA's index. Bond yields move inversely with prices.

But on Friday, after dropping 8 bps to 1.354%, the lowest in over two weeks, the 10-year yield was up 2.5 bps to 1.457% at 1547 GMT. Italian 10-year yields were up 7 bps to 3.547% after falling 30 bps through Wednesday and Thursday.

The spread between Italian and German 10-year borrowing costs widened by 4.5 bps to 210 bps.

Friday's main focus was Germany's Ifo business sentiment survey which showed that morale has fallen more than expected but that a recession was not yet in sight despite rising energy prices and the threat of gas shortages.

"The (Ifo survey) current conditions had not quite worsened as much as yesterday's PMIs would have suggested, so maybe it's the absence of additional bad news," said Chris Scicluna, head of economic research at Daiwa Capital Markets, noting stock markets also rallied on Friday.

Bond markets are also likely consolidating after sharp moves on Thursday, Scicluna added.

"Those moves were probably overdone, because the impact of every piece of news, whether on the upside or downside, these days tends to be magnified by the market."

The new instrument being designed by the European Central Bank to contain a divergence in borrowing costs risk will not include a goal for specific yield spreads, Portugal's central bank governor and ECB policymaker Mario Centeno said on Friday.

Meanwhile, ECB vice-president Luis de Guindos poured cold water on the notion that the ECB would sell bonds to offset any fresh purchases it makes to fight a rise in borrowing costs for the most indebted countries. (Reporting by Yoruk Bahceli and Samuel Indyk; Editing by Kim Coghill, Jan Harvey and Hugh Lawson)

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