UPDATE 2-Longer-dated bonds lead euro zone debt rally on coronavirus worries

Longer-dated eurozone government bonds led a broad rally on Thursday as concern about an economic slowdown in the region and damage to Asian growth from China's coronavirus created strong demand for safe-haven government bonds.

The coronavirus continues to shape risk appetite. China has reported a large drop in new cases and announced an interest rate cut to buttress its economy. However, South Korea reported a jump in new cases, two people died in Japan and researchers said the virus spreads more easily than previously believed. The Spanish 30-year bond led Thursday's bond rally, with the yield down 7 basis points in late trade at 1.03%. The 20-year Dutch government bond returned to a negative yield at -0.008% for the first time in three months, ending down 4 bps on the day.

Macroeconomic concerns behind coronavirus are looming, and the market is driven by liquidity expectations, said Commerzbank rates strategist Rainer Guntermann. In recent weeks traders have been ramping up their bets for a rate cut from the ECB by the end of the year.

Guntermann said the outperformance of the longer-dated bonds led by Spain demonstrated that investors are continuing to hunt for yield. Lower-rated Southern European bonds offer investors a pick-up given their positive yields, compared to the vast majority of the eurozone government bond market where yields are stuck in negative territory.

Meanwhile, German and Dutch yield curves came closer to returning fully to negative territory, with their 30-year bond yields trading at 0.05% and 0.04% respectively. The 10-year German government bond yield was down 3 basis point at -0.44%, close to three-and-a-half-month lows reached earlier in February.

Inflation expectations slipped below 1.20% for the first time since late November on Thursday, according to a key market gauge, far below the ECB's close to but below 2% target. Purchasing managers indexes and eurozone inflation numbers released on Friday will be watched closely to give further indication of the economic impact coronavirus has had.

ECB policymakers took a cautiously optimistic view on the euro zone's growth prospects in January, the accounts of their policy meeting showed on Thursday before the coronavirus outbreak created a new challenge for global growth. Italy's 10-year bond yield fell 3 basis points to 0.91%, its lowest since Feb. 3. The country's bonds largely shrugged off renewed concerns about a breakdown in the governing coalition as investors hunted for better returns in markets like Italy and Greece.

Analysts at Unicredit said Matteo Renzi, leader of Italy Alive, had further raised tensions within the coalition this week but did not announce any steps that could cause a government crisis. "We regard recent political developments mostly as noise, but recognize that uncertainty is on the rise," they wrote, noting that the spread between Italian and German bond yields had widened but remained below 140 bps - last at 134 bps.