French-German bond yield spread returns to pre-crisis levels

* French borrowing costs just 15 bps away from German levels

* Lower-rated euro zone bonds outperform as FDP risk fades

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

By Abhinav Ramnarayan

LONDON, Nov 21 (Reuters) - The gap (Frankfurt: 863533 - news) between French and German borrowing costs shrank on Tuesday to its tightest since before the 2010-2012 euro zone debt crisis, as confidence in the bloc's economic prospects swelled and "Frexit" fears faded from memory.

In February, the spread between the government bond yields of the euro zone's two largest economies widened to as much as 80 basis points on prospects of a potential presidential election win for anti-euro candidate Marine Le Pen (Other OTC: PENC - news) .

But the victory of centrist Emmanuel Macron reversed that trend, and a rare political impasse in Germany has narrowed the gap further.

On Tuesday, the 10-year spread tightened to 15 basis points, a level last seen in August 2009, well before a series of sovereign debt crises hit the single currency bloc.

"All the political uncertainty in France in the first half of the year has faded away and the market is focusing on macroeconomic factors," said DZ Bank analyst Sebastian Fellechner.

The political calm in France stands in contrast to events in Germany, where Chancellor Angela Merkel raised the prospect of new elections after coalition talks collapsed at the weekend.

Analysts also pointed to generally positive sentiment towards the euro zone as another reason for tightening spreads across the bloc.

With (Other OTC: WWTH - news) major debt supply out of the way, European Central Bank largesse continuing to flow and with no major headline risks for the rest of the year, the market has no reason to bet against the euro zone at the moment, said ING strategist Benjamin Schroeder.

"All those shorting France have slowly been squeezed out and no-one is willing to take the opposite position now, with no obvious risks looming and with supply winding down," said ING strategist Benjamin Schroeder.

On Tuesday, the premium that investors demand to hold Italian debt over German was at 141 bps, close to a one-year low hit earlier this month.

Southern European bond yields fell 3-4 bps on Tuesday, as investors continued to take advantage of the higher yields they offer in a benign environment.

The breakdown of a potential "Jamaica coalition" between Merkel's CDU party, the pro-business FDP and the Greens may be benefiting them, said Fellechner of DZ Bank.

"The (FDP) liberals would have been much more hard on the Southern European countries, so now that they refuse to work on a Jamaica coalition, that is good for peripheral spreads," he said.

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(Reporting by Abhinav Ramnarayan, Editing by Catherine Evans and John Stonestreet)