LONDON, Aug 13 (Reuters) - Euro zone bond government yields dipped across the board on Tuesday, pushing the German 10-year yield to a one-week low as softer-than-expected U.S. producer prices data calmed nerves ahead of key consumer prices reading on Wednesday.
The bloc's bond yields had fallen to multi-month lows last week after a weaker-than-expected U.S. payrolls report fuelled worries about a U.S. economic downturn that could warrant bigger interest rate cuts from the Federal Reserve and boost the U.S. Treasury market. Yields move inversely to bond prices.
While euro zone bond yields have stabilised somewhat over the week, data on Tuesday showing U.S. producer prices increased less than expected in July put pressure on them again.
The 10-year German bond yield, the benchmark for the euro zone, declined 3.8 bps to 2.187% - its weakest level in since Aug. 6. During the height of the market turmoil last week, it hit its lowest since January at 2.074%.
The interest rate-sensitive 2-year Schatz yield dropped 4.8 bps to 2.349%. It sank to a more than one year low of 2.151% last week.
"There are some worries that CPI could surprise. So it's nice to go into that knowing that the PPI number, which is an important component of the PCE number, is actually behaving a bit better than normal by coming in lower," said Michiel Tukker, senior European rates strategist at ING.
The personal consumption expenditures (PCE) price index is used by the Fed to gauge underlying price pressures.
"But there are so many questions out there. So in that sense, volatility is definitely here to stay and is not going to be solved with one data point," ING's Tukker added.
Focus shifts to Wednesday's U.S. consumer price figures, with investors looking for signs that inflation is slowing enough for the Fed to lower rates next month and by how much.
Futures markets are almost evenly split on whether the central bank will lower borrowing costs by 25 or 50 basis points in September, having last week fully priced in a half-point move when concerns about the U.S. economy sent bond yields and stocks tumbling.
"We're sitting and waiting for tomorrow," said Jens Peter Sørensen at Dankse Bank. "We have the expectation that the Fed is going to cut rates but it's more a matter of how much and for how long."
While U.S. data is signalling a slowdown in economic growth rather than an outright recession, data from the euro zone continues to paint a more sombre picture.
German investor morale worsened by more than expected in August, posting its strongest decline in two years, the ZEW economic research institute said on Tuesday.
Having cut rates in June, markets are assigning a more than 90% chance that the European Central Bank moves again in September with a quarter-point cut, following a pause in July.
A Reuters poll of economists showed the ECB is likely to cut its deposit rate twice more this year, in September and December, fewer reductions than markets currently expect.
Italy's 10-year yield was 6 bps lower at 3.58% - its lowest since March 14 - narrowing the yield gap between Italian and German 10-year bonds to 138.6 bps.
Italy's two-year yield was down 4.6 bps at 2.83%. (Reporting by Samuel Indyk in London and Sruthi Shankar in Bengaluru; Editing by Kirsten Donovan, Bernadette Baum and Ros Russell)
