Germany sells two-year debt at record low yield in safety rush

(Updates prices for close)

By Abhinav Ramnarayan and John Geddie

LONDON, Sept 28 (Reuters) - Germany sold two-year bonds at a record low yield on Wednesday as concerns about the health of the European financial industry kept demand high for debt seen as a safe haven.

The euro zone's benchmark issuer sold 3.191 billion euros at minus 0.7 percent, a record low yield at an auction.

Two-year yields in secondary markets held just above an all-time low of minus 0.711 percent touched on Tuesday, while 10-year yields hit a six-week low of minus 0.15 percent.

German government bond yields -- a refuge in times of market stress -- have fallen sharply this week on concerns the country's largest lender Deutsche Bank (LSE: 0H7D.L - news) may need Berlin's help to settle a $14 billion fine from the U.S. government.

The German government and financial authorities are preparing a rescue plan for Deutsche Bank in case the lender is unable to raise capital itself to pay for costly litigation, German weekly Die Zeit reported on Wednesday.

"The current yield levels I think to some extent is an over-reaction so we could see some move in yields as the market calms down and German (10-year) Bunds move closer to zero," said DZ Bank analyst Rene Albrecht.

The rally may also have been exacerbated by the European Central Bank's asset purchase programme, said Mizuho rates strategist Antoine Bouvet.

"Whenever yields fall, the universe of bonds eligible for quantitative easing shrinks and the ECB ends up buying longer-dated Bunds and pushing yields down further. As a result, any rally is magnified," he said.

The ECB cannot buy bonds that yield less than minus 0.40 percent, the central bank's deposit rate.

On Tuesday, Swiss wealth manager Pictet said a record 65 percent of the German government bonds on the shopping list of the ECB's asset-purchase scheme are ineligible for this reason.

ECB President Mario Draghi rejected German criticism of the bank's super-loose monetary policy on Wednesday, calling sub-zero rates a necessity.

Grilled by German lawmakers who say the bank's monetary policy has damaged the euro zone and fuelled the rise of the populist right, Draghi said Germans were net beneficiaries of the ECB's policies and action from governments, including Berlin, were a precondition for rates to rise.

According to several participants in a meeting between the ECB chief and German lawmakers, Draghi said that constant attacks may force the ECB to take even more extensive measures to be effective.

For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Reporting by Abhinav Ramnarayan and John Geddie; Editing by Catherine Evans)