Neighbour Ireland feels Brexit tremors in bond market

* Ireland (Other OTC: IRLD - news) 's borrowing premium highest in a year

* Investors punish Dublin for close UK trade links

* Worries over June 23 vote push investors into safer bets (Updates prices to close)

By John Geddie

LONDON, June 15 (Reuters) - The premium Ireland would pay to borrow compared with euro zone benchmark Germany hit its highest level in nearly a year on Tuesday as investors fretted about the economic impact on Dublin of a potential British exit from the European Union.

The gap (NYSE: GPS - news) between Irish and German 10-year bond yields widened to 88 basis points in early trade, the highest since July 2015, according to Tradeweb.

Britain holds a referendum on its EU membership on June 23, with some recent polls showing a lead for the "leave" camp, bookmakers slashing the odds on a Brexit, and the nation's biggest-selling newspaper urging readers to quit the bloc.

For Ireland, an economy still recovering from a banking collapse in 2008-2009 and whose nearest and largest trading partner is Britain, a vote to leave could have far-reaching consequences.

"Ireland in the last few days has been the clear underperformer as markets penalise the country's strong trade links with the UK," ING rates strategist Martin van Vliet said.

Aside from the economic impact of Brexit, peace in British-ruled Northern Ireland, security of energy supplies and freedom of movement for the large numbers of Irish citizens working in Britain might also fall into doubt.

The gap or spread between Irish and German bond yields, which serve as a measure of their likely borrowing costs, has risen 23 bps this week alone. That is more than for any other euro zone country bar junk-rated Portugal and Greece, which have been shunned as investors take cover in safer assets.

Cantor Fitzgerald, one of Ireland's main bond dealers, said the Irish spread to Germany could widen a further 20 bps in the event of Brexit.

Investors have become so concerned Britons will vote to leave that 10-year German yields turned negative on Tuesday, while Berlin on Wednesday sold 10-year debt at a record low average yield of 0.01 percent at auction.

In Ireland, banks are preparing for any potential disruption and volatility in financial markets from a Brexit vote, the deputy governor of its central bank said on Tuesday.

Ratings agencies have also warned that Brexit could lead to downgrades for euro zone economies including Ireland, a potential setback for the bloc's fastest growing economy.

In terms of exports to other EU countries, Ireland is most dependent on Britain, selling goods and services worth nearly 12 percent of its GDP there. It (Other OTC: ITGL - news) also has one of the biggest exposures to the UK in terms of foreign direct investment, according to data published by ratings firm DBRS on Wednesday.

Research by Davy Stockbrokers shows that a 1 percent decrease in UK economic output has led in the past to a 0.3 percent drop in Ireland.

"Ireland is the most exposed euro zone country to any economic fallout from a Brexit," Jack Allen, European Economist at Capital Economics said in a note this week.

Ireland's benchmark ISEQ equity index has shed 10 percent this year, roughly in line with falls on the pan-European STOXX 600 index. (Reporting by John Geddie; Additional reporting by Dhara Ranasinghe; Editing by Nigel Stephenson and Catherine Evans)