German bond yields set for biggest quarterly fall in 4-1/2 years

(Updates prices)

By John Geddie and Dhara Ranasinghe

LONDON, March 31 (Reuters) - Europe's benchmark German government bond yields were set on Thursday for their biggest quarterly fall in 4-1/2 years, with fresh rounds of central bank monetary easing and concerns about the global economy driving demand for the top-rated debt.

With (Other OTC: WWTH - news) scant signs of any uptick in growth or inflation reversing the trend any time soon, many analysts expect German bonds to keep performing, hastened by the ECB buying up a large share of euro zone government bonds through its QE purchases.

Monthly QE purchases will be increased by a third to 80 billion euros ($91 billion) on Friday as part of the latest stimulus package unveiled by the central bank this month.

So far this year German bonds have proved one of the best bets for global investors, returning 10 percent off the back of a near 8 percent losses in 2015. http://reut.rs/1ZKAaO6

Signs of a slowdown in China, as flagged by Standard & Poor's which revised its outlook on the country's credit rating to negative on Thursday, have weighed down riskier stock markets and the outlook for oil prices and inflation.

Data on Thursday showed consumer prices continued to fall in the euro zone in March while investors' long-term inflation forecasts languish near record lows.

German 10-year yields have shed nearly 50 basis points this quarter, standing at 0.16 percent and within touching distance of record lows of 0.05 percent set last year.

That marks their biggest decline since the third quarter of 2011, when they dropped over 100 basis points as investors took refuge in the top-rated debt fearing Italy and Spain, the bloc's third- and fourth-largest economies, could be headed towards sovereign bailouts as the euro debt crisis gathered steam. http://reut.rs/22R4c87

FLIGHT TO SAFETY

The drop has outpaced falls in U.S (Other OTC: UBGXF - news) . Treasury yields, which have fallen 46 bps to 1.81 percent and were set for their biggest quarterly decline since mid 2012.

"The way the year started meant the combination of a flight-to-safety and falling inflation expectations pushed bond yields lower," said Jan von Gerich, Nordea chief fixed income analyst. "Those fears have abated, but the damage done to the outlook has been big enough for central banks to turn dovish."

Rabobank estimates that bond supply in April, when redemptions and ECB bond buying is stripped out, will stand at minus 1.96 percent of outstanding debt stock worth roughly 6.2 trillion euros from 10 euro zone issuers.

The bank forecasts Bund yields to end 2016 at about minus 0.10 percent, implying a fall of more than 20 basis points from current levels.

Yet analysts remain wary of a sharp retreat from these levels as seen in the middle of last year when Bund yields rose 100 basis points in a matter of weeks.

"These sudden spikes are very difficult to forecast," said Kim Liu, senior fixed income strategist at ABN Amro. "What we know is that as bonds become more expensive and liquidity deteriorates, the likelihood increases of sudden jumps in yields."

The future direction of yields will also depend on the outlook for inflation, which up until now has been quelled by low oil prices. U.S. crude hit its lowest price in more than two weeks on Thursday as the country's stocks reached yet another record high, adding to concerns about global oversupply.

One of the ECB's most closely-watched market indicators of long-term inflation, the five-year, five-year forward rate, is hovering just above a record low of 1.36 percent hit last month, well below the ECB's near 2 percent target rate. ($1 = 0.8821 euros) (Graphics by Alasdair Pal and Vincent Flasseur; Editing by Raissa Kasolowsky and David Holmes)