GLOBAL MARKETS-Euro yields, stocks fall on economic setback fear

By Sujata Rao

LONDON, Aug 14 (Reuters) - Bond yields across the euro zone hit record lows on Thursday and the euro hovered near its weakest in nine months after Germany reported its economy unexpectedly shrank in the second quarter, casting doubt on the region's fragile recovery.

Germany's 0.2 percent contraction came after data earlier this week showed gross domestic product fell in Japan, Chinese lending declined and U.S. retail sales stalled.

The setbacks also weighed on global equity markets and crude oil futures, with the latter trading just off 13-month lows .

In addition, the French economy failed to expand for a second straight quarter. Combined with the threat to growth from sanctions on Russia, the slowdown in the euro zone's two biggest economies leave the euro zone's recovery looking increasingly endangered.

World stocks pulled away from one-week highs reached earlier this week. Europe's FTSEurofirst 300 index and Frankfurt's DAX slipped around 0.3 percent . France's CAC index fell half a percent.

Analysts now reckon the ECB will have no choice but to embark on more stimulus if it is to support growth in the euro zone.

Those expectations pushed German 10-year yields to record lows, touching 0.998 percent. French yields fell as well, to 1.392 percent, also a record low. Spanish bond yields reached record lows as well, dropping to 2.442 percent

Jonathan Loynes, chief European economist at Capital Economics said it was now clear that the euro zone was too weak to tackle peripheral Europe's debt problems or eliminate the danger of deflation.

"As such, we still believe that the ECB needs to implement further policy action - probably in the form of full-scale quantitative easing - to try to bring the euro down and re-ignite the recovery," Loynes told clients.

The euro hovered near nine-month lows against the dollar . Sterling also struggled, declining to a four-month low of $1.6657. The pound has dropped almost 3 percent since climbing to six-year high in the middle of July.

Further disappointment is likely from data due at 0900 GMT that is forecast to show that the euro zone economy as a whole expanded just 0.1 percent in the second quarter. Analysts say after the German and French numbers even that much growth looks unlikely.

"The GDP numbers for France and Germany released today were pathetic, and keep in mind that these numbers do not have any sanctions stamp on them yet. One can only imagine how far these numbers could wane once the sanctions effect is factored in," said Naeem Aslam, chief market analyst at online brokerage AvaTrade.

(Editing by Larry King)