* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts, updates with data releases, adds comments)

By Yoruk Bahceli

AMSTERDAM, July 30 (Reuters) – Safe-haven German government bond yields hit new 2-1/2 month lows on Thursday as the country’s economy showed a worse-than-expected, record contraction in the second quarter.

Investors are focusing on economic data after the U.S. Federal Reserve left interest rates near zero on Wednesday. Weak readings hit riskier assets like stocks with fears of a potential second wave of coronavirus infections which could put Western economies back in lockdown.

“Data is increasingly important now that the market has now come to terms with a second wave,” Mizuho analysts told clients.

The German economy contracted by 10.1% in the second quarter in its steepest plunge on record, worse than the 9% contraction predicted by Reuters economists and wiping out nearly 10 years of economic growth.

“The drop was even harsher, more pronounced than expected, which is something that is also being reflected by the market,” said DZ Bank strategist Daniel Lenz.

“There has been a lot of optimism in the spring with corona numbers going down and some early indicators going up. Now, with this very weak reading of German GDP numbers…(there is an) expectation that maybe some of the other European readings will be even worse,” he said, referring to the likes of Italy and Spain.

Germany’s 10-year yield fell to a new 2-1/2 month low at -0.53%, dropping further below the -0.50% level where it had found support in recent weeks.

Lenz added that the increase in coronavirus infections and uncertainty around the agreement of a new stimulus plan in the U.S. were also supporting safe-haven bonds.

He said 10-year yields could fall to near -0.60%, a level last touched at the height of coronavirus market panic in mid-March, unless concerns eased.

The uncertainty cast a shadow over data showing euro zone economic sentiment rebounded more than expected in July.

Inflation in German states eased in July, data showed, with the national reading due later in the session expected to show inflation fall to 0.4% year-on-year, from 0.8% in June.

ING analysts watching the inflation data noted Greek ECB policymaker Yannis Stournaras’ assertion that the trajectory of the bank’s emergency bond purchases will depend mostly on the inflation outlook.

“A soft (inflation) print would be perceived as adding to the case for more stimulus,” they said.

Italian 10-year yields fell to their lowest since early March at 1.036%, as the country sold five and ten-year bonds via auction. (Reporting by Yoruk Bahceli, Editing by Timothy Heritage, Kirsten Donovan)

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