By Daniel Flynn
PARIS (Reuters) - France was expected to draw solid demand for its 10-year bonds at an auction on Thursday, despite the lingering threat of a downgrade to its AAA credit rating, as yields offer an attractive premium to benchmark German bunds.
The country kicks off its 2012 long-term debt issuance program with a regular-sized auction of 7 to 8 billion euros of 10- to 30-year OAT bonds, a day after Germany saw demand pick up at its first auction of the year on Wednesday.
France's top-notch rating is hanging by a thread due to its slowing economy, high structural deficit and banking exposure to the euro zone's periphery.
The AFT debt agency will offer the 3.25 percent OAT maturing on October 25 2021, the 4.25 percent OAT maturing on October 25 2023, the 4.75 percent OAT maturing on April 25 2035, and the 4.50 percent OAT maturing on April 25 2041.
Auction results are due around 1000 GMT. All lines have a settlement date of January 10.
Eric Oynoyan, interest rate strategist at BNP Paribas, said a 50 basis point widening in the spread between French 10-year bonds and benchmark German bunds over the last month had made French bonds more attractive.
With French 2-year BTAN bonds stable over the last month, the French yield curve had steepened compared to Germany's.
"The French curve appears mispriced relative to the German," Oynoyan said. "There is a strong argument in favour of the French 10 years. They are attractive -- the October 2021 bond in particular."
French benchmark 10-year bonds were yielding around 3.32 percent on Wednesday, with a spread to benchmark German 10-year bunds at around 147 basis points, well below its euro era high of more than 200 basis points reached in November.
Oynoyan said there could be some flattening of the yield curve between the 2- and 10-year French bonds, with solid demand for 10 year bonds from local investors, particularly insurers.
Pension funds, by contrast, appeared hesitant to pick up French 30-year bonds, preferring German ones, he said.
Germany sold 4.06 billion euros of 10-year bonds on Thursday, with its first auction of the year seeing a recovery in demand supported by large bond redemptions and coupon payments which left investors flush with cash. That came as a relief after the upset of a November auction which saw bids worth less than the 6 billion euros on offer.
With a heavy schedule of euro zone debt maturing this year, traders remain nervous about government finances despite an unprecedented injection of nearly half a trillion euros of cheap funding for banks last month.
France plans to issue up to 178 billion euros in medium- and long-term government debt, net of buybacks, this year down only slightly from 184 billion euros in 2011, despite the threat to its AAA credit rating.
Last month, Fitch put France's rating on a negative outlook and Standard and Poor's, which placed 15 euro zone countries under review, singled out France as the only AAA country facing a possible two-notch downgrade.
Economists have also warned that with its economy expected to enter recession in the first quarter of this year, it will need more painful austerity measures to reach a deficit target of 4.5 percent of GDP this year, though a looming presidential election may complicate that.
Adding to investors' anxiety, Socialist election frontrunner Francois Hollande -- who leads Sarkozy by a wide margin in polls -- has pledged to renegotiate Europe's fiscal compact.
Nonetheless, France drew strong investor demand in its first Treasury bill action of the year, with short-term yields rising only slightly from record lows reached in its last sale of 2011.
(Reporting By Daniel Flynn; Editing by Toby Chopra)