Euro zone bond yields fall on weak French data, set for weekly rise

LONDON, Feb 21 (Reuters) - Euro zone bond yields fell on Friday after French survey data pointed to a worse-than-expected outlook for the economy, potentially bolstering the case for deeper interest rate cuts by the European Central Bank.

Yields were nonetheless on track for their biggest weekly rise since early January as investors price in the likely need for more borrowing to fund higher defence spending.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, fell 4 basis points (bps) to 2.489%. Yields move inversely to prices.

Yields across the bloc fell after data showed the French purchasing managers' index (PMI) - a gauge of private sector activity - fell by much more than expected in February.

PMI data for the whole euro zone showed the bloc saw very tepid growth this month.

"That's not great, but there's at least no sign of activity deteriorating further," said Bert Colijn, an economist at ING.

"The weakness was concentrated in France as Germany and the rest of the euro zone showed expanding output."

Italy's 10-year yield IT10YT=RR was lower by 4 bps at 3.57%, while France's was down 3 bps at 3.236% FR10YT=RR.

The gap between Italian and German yields stood at 108 bps DE10IT10=RR while the French-German spread was at 70 bps, after falling to its lowest since July at 66 bps earlier this week.

Benchmark German yields have risen around 7 bps this week after U.S. President Donald Trump shocked allies by initiating talks with Russia over ending the Ukraine war.

Figures in his administration have said Europe will have to shoulder more of the security burden.

That implies higher spending on defence and so higher borrowing via bond markets, adding to upward pressure on yields.

Investors on Sunday will be watching Germany's election, which could result in a conservative-led government that will potentially spend more to boost the economy, or a heavily split vote that leads to drawn-out coalition negotiations and political deadlock.

Germany's two-year bond yield DE2YT=RR, which is more sensitive to ECB rate expectations, was last down 4 bps at 2.115%.

Traders on pricing were pricing in roughly 77 bps of further ECB rate cuts on Friday, up from about 74 bps on Thursday 0#EURIRPR.