* Smooth German sale of two-year bonds with 0 pct coupon * EU leaders to discuss growth, joint euro zone bonds * Summit not expected to produce concrete measures By Marius Zaharia LONDON, May 23 (Reuters) - German government bond yields fell on Wednesday after an auction of interest-free two-year debt strong showed demand for assets expected to offer shelter from the threat of Greece leaving the euro. The new German bond carried a zero percent coupon, and sold at auction with an average yield barely higher than that, but investors were not deterred. They bid for 1.7 times the amount on offer, suggesting German yields may have room to fall below recent record lows in coming weeks. The so-called "flight to quality" is likely to continue in the run-up to Greek elections on June 17, which may produce a government opposed to the terms of the country's bailout deal. Without a deal Greece may have to leave the euro. "People just want to make sure that they are going to get their money back. The outcome is so binary as to what can happen in the next month or so that people just don't want to take risks," said Gary Jenkins, director at Swordfish Research. "The only way yields would fall further...is if people pay Germany to look after their money for them," he said, adding that it was possible German bond yields could turn negative if sentiment worsened. Two-year benchmark yields were 2 basis points lower on the day at 0.04 percent, compared with 0.07 percent before the auction. BNP Paribas rate strategist Patrick Jacq expected two-year yields to stabilise just above zero in the near term as investors sought higher-yielding longer maturities. Benchmark 10-year German yields were 6.2 bps lower at 1.413 percent, less than 2 bps above the record lows hit last week and almost a full percentage point below where they were six months ago. Stuart Thomson, chief market economist and fixed income fund manager at Ignis Asset Management, a 70 billion pound ($111 billion) fund, said he had bought Bunds in recent weeks. He believed another Greek bailout was more likely than the country leaving the euro and did not expect policymakers to come up with a solution to the debt crisis that would create "escape velocity". "We believe there is a shortage of safe havens in this environment and we think they (Bunds) are likely to perform extremely well over the next six months," Thomson said. German bond yields could rise 20-30 basis points if Greek euro exit fears wind down but this was likely to be temporary. Bund futures were up 80 ticks on the day at 143.89, having doubled their intra-day gains after the auction results. EU SUMMIT European Union leaders meeting later on Wednesday are expected to discuss measures to foster growth but to remain divided over joint euro zone bonds. The summit is not expected to produce any plan that would restore optimism among investors and curb their appetite for safe-haven assets, though. French President Francois Hollande is expected to push debt mutualisation, to which Germany is opposed. "The Greek elections are quite a critical peg for (European) policymaking in the coming weeks and months," Commerzbank rate strategist Rainer Guntermann said. "Politicians will have to wait for the outcome of the (Greek) elections so concrete measures to tackle the crisis are unlikely at the summit," he said, adding that he expected the market to remain risk averse over the coming weeks.

Source