UPDATE 2-German 10-year bond yields hit 5-week low, strong PMI stems fall

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

LONDON, March 24 (Reuters) – Germany’s 10-year bond yield fell to a five-week low on Wednesday, a sign of unease that tighter restrictions to contain a fresh wave of COVID-19 could hurt the euro zone economy.

Still, IHS Markit’s flash composite PMI, a closely-tracked economic indicator, bounced above the 50 mark separating growth from contraction to 52.5 in March compared to February’s 48.8, its highest since late 2018.

The news tempered the rally in bond markets but yields were set to end the day lower and prices higher, as a note of caution prevailed.

Much of Europe is suffering a third wave of coronavirus infections and renewed lockdown measures, as well as a slow vaccine rollout, meaning the final reading of the survey and April’s numbers could be more subdued.

Latest headlines from big euro zone economies such as Germany, which has extended its lockdown to April 18, has encouraged a return to safe-haven bonds. European stocks on Wednesday fell to two-week lows.

Signs of a pick-up in the pace of the European Central Bank’s bond purchases have also supported bond markets.

“While Bund yields may struggle to break below the current range the refocus on the domestic pandemic front against a backdrop of increased ECB buying – even if only moderately so – can contribute to keeping yields lower for now,” said Benjamin Schroeder, senior rates strategist at ING.

Germany’s 10-year Bund yield fell as low as -0.375% on Wednesday, its lowest level in five weeks. It was last down 1 basis point on the day at -0.36% at 1549 GMT; 6 bps lower so far this week.

Most other 10-year euro zone bond yields were down similarly.

This week’s fall in yields contrasts with sharp rises in recent weeks, fuelled by expectations of a strong U.S.-led economic recovery and a pick-up in inflation.

Sarang Kulkarni, a fund manager in Vanguard’s fixed income group in London, said markets have started to think about what the world looks like once economies normalise — a theme that was likely to play out over the next 24 to 36 months.

Kulkarni said a key focus for sovereign and corporate bonds markets, especially once fiscal stimulus kicks in, would be when central banks start to remove stimulus.

“There was always this argument that central bank support was needed until fiscal support came into place. And now that’s coming in and we have the deployment of the EU recovery fund later this year,” he said.

“When do they (central banks) really start to step away? I don’t think they will be in a rush to remove stimulus, but that is the big question on everyone’s mind.”

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