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MARKETS LIVE BLOG:

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GRAPHIC-With Euro zone bonds, going long is better than going south

Reuters

By Marius Zaharia and Vincent Flasseur

LONDON, March 19 (Reuters) - Investors who took the extra risk of holding longer-dated euro zone bonds at the start of the year are being better rewarded than those who took the risk of seeking higher yields in lower-rated debt, data shows.

That is a function of the subdued inflation and growth outlook in the euro zone that is likely to keep borrowing costs low across the bloc, while fuelling doubts about debt sustainability in lower-rated countries, analysts say.

The technicalities of the European Central Bank's trillion-euro bond buying programme have also boosted the returns offered by "duration risk" relative to "credit risk."

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In triple-A rated Germany, longer maturities have returned 10.7 percent year-to-date, compared with 1 percent or less in maturities up to 7 years and 2.5 percent in 7-10 year bonds, according to Thomson Reuters data.

http://link.reuters.com/guz34w

In Italy, whose ratings range from BBB- to BBB+, 7-10 year bonds offered returns of 3.7 percent, more than those produced by their German counterparts, but less than half as much as long-dated German paper.

Of course, investors who moved into both longer-dated and lower-rated bonds have benefited most. Italian bonds longer than 10 years have returned 11.5 percent.

The ECB's quantitative easing (QE) programme pushes investors to seek yield wherever it is available, but it has a particularly strong impact on the less liquid long-dated bonds. Most euro zone debt expires in the next decade.

If QE works, however, longer-dated bonds would be the first ones to price in better growth and higher inflation and their yields would rise.

"QE technicalities are likely to remain a very strong driver in the very near term," said Luca Cazzulani, rate strategist at UniCredit. "In the medium term, QE should revive inflation expectations. If on top of that you get improving signals from the economy, you will get a repricing in yields on the upside." (Reporting by Marius Zaharia)