UPDATE 1-Euro zone bond yields ease on Turkish tumult, European virus surge

* Euro zone yields drop 1-2 bps after Turkey scare

* ECB accelerates bond purchases

* Yields in U.S. 10-year Treasuries back below 1.70%

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Adds comments from Lagarde and Knot, ECB purchases; updates prices)

LONDON, March 22 (Reuters) – Euro zone government bond yields eased on Monday as a plunge in the Turkish lira boosted demand for safer assets and rises in coronavirus infection rates clouded the continent’s economic outlook.

President Tayyip Erdogan shocked markets by replacing Turkey’s hawkish central bank governor with an ally who has criticised high interest rates, sparking a selloff in stocks and market talk about possible capital controls.

German bond yields were also under downward pressure as concerns about rising COVID-19 cases in the euro area encouraged investors to bet that the European Central Bank will want to keep rates as low as possible.

“The near-term economic outlook is subject to uncertainty, relating in particular to the dynamics of the pandemic and the speed of vaccination campaigns,” President Christine Lagarde said in a post on the ECB’s website.

The Bundesbank warned that Germany’s economy was likely to shrink sharply this quarter as pandemic-fighting curbs hit the services sector and even the booming construction industry.

The Dutch central bank (DNB) also said economic growth would recover later than expected as a broad lockdown continues in the of the Netherlands.

The ECB announced that it had accelerated its bond purchases with a net 28.672 billion euros ($24.06 billion) of assets last week as part of its quantitative easing programme, compared to 19.303 billion euros the previous week.

ECB governing council member Klaas Knot said a few hours before the figures were disclosed that the acceleration in bond purchases was a temporary move, meant to reduce borrowing costs until growth and inflation in the monetary union pick up.

Knot said a “major part” of the recent rise in euro zone yields was caused by the improving economic outlook, but some of it constituted an unwarranted response to rising yields in the United States, where economic fundamentals have improved faster.

The past month has seen a dramatic selloff in the United States government bond market, sparked by worries about rising inflation as the U.S. economy rebounds.

The U.S. 10-year yield shot up last week to above 1.75%, its highest since January 2020.

It has retreated since, and stood at 1.6769% at 1555 GMT, as investors fretted about the fallout from the plunge in the Turkish lira.

The benchmark 10-year German government bond yield dropped 1.5 basis points to -0.309%.

“Going forward, we think that Bund outperformance relative to USTs (U.S. Treasuries) will continue, even if today’s data on ECB weekly purchases do not indicate an acceleration. Indeed, the economic outlook in the U.S. looks more favourable than in the euro zone,” UniCredit analysts said in a research note.

Other core and peripheral euro zone bond yields were down by similar margins .

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