Euro zone bond yields edge up from multi-week lows ahead of ECB decision

By Samuel Indyk

LONDON, June 4 (Reuters) - Euro zone bond yields rose modestly on Wednesday having fallen the day before as benign inflation data helped solidify expectations for a rate cut from the European Central Bank, but fiscal concerns still lingered.

Data on Tuesday showed consumer price inflation in the euro area slowed to 1.9% last month from 2.2% in April, its first time at or below the ECB's 2% target since October.

The ECB has cut interest rates seven times since last June and another move is almost fully priced in for Thursday's meeting.

For the year, money market traders are pricing about 55 basis points (bps) of easing, implying about one more quarter-point cut after the expected move this week.

"Almost all on the ECB are well aligned for a 25 basis point cut but it's more a question of what happens after," said Jussi Hiljanen, chief rates strategist at SEB.

"There's a fair chance they take a pause in July and then look at the situation again after the summer when they publish new staff projections."

Germany's 10-year yield DE10YT=RR, the benchmark for the euro area, was last up 2 bps at 2.525%. It fell to its lowest since May 8 on Tuesday at 2.485%.

Germany's policy-sensitive two-year yield DE2YT=RR was up 1.5 bps at 1.79%, within its recent tight range.

Traders remain cautious as worries about the fiscal sustainability of the U.S. and other major economies continue to draw attention.

But Germany's relatively better debt trajectory to peers, including the U.S., Japan and Britain, should help shield its bond market from rising long-term borrowing costs, despite its large spending commitments.

"It's very difficult to make a case for buying U.S. Treasuries over core European bonds," SEB's Hiljanen said.

The yield on 10-year Treasury notes fell to its lowest in over three weeks on Wednesday after U.S. service sector and private payrolls data, and was down 7.3 bps at 4.387%.

On Wednesday, Germany's cabinet approved a first tax relief package worth 46 billion euros ($52.40 billion) through 2029.

Germany's 30-year yield DE30YT=RR was up 2 bps on Wednesday at 3.4%.

The collapse of the Netherlands' government on Tuesday saw little reaction in Dutch government bond markets but investors were preparing for months of political uncertainty in one of the only remaining triple-A rated sovereigns.

"For markets, however, the increased likelihood of a mainstream centrist government should outweigh the temporary increase in uncertainty," said Citi rates strategist Aman Bansal.

"This doesn't change our view that the 10-yr spread to Bunds could eventually converge to its 2017 lows of around 5bp," Bansal added.

The Dutch 10-year yield NL10YT=RR was up 2 bps at 2.746%, while the yield gap between the Dutch and German 10-year yields DE10NL10=RR was little changed on the day at about 20 bps.

Italy's 10-year yield IT10YT=RR, the benchmark for the euro area periphery, was up 1 bps at 3.505% after falling to its lowest since February 28 at 3.475% on Tuesday.

($1 = 0.8778 euros)