Euro zone bond yields edge lower as Fed rate cut looms

By Jaspreet Kalra and Canan Sevgili

Sept 17 (Reuters) - Euro zone government bond yields eased on Wednesday ahead of a widely-expected U.S. Federal Reserve rate cut later in the day, with the focus on any cues over the extent of easing the central bank may deliver this year.

Germany's 10-year bond yield DE10YT=RR, the benchmark for euro zone debt, was down 2 basis points at 2.67%.

Similarly, U.S. 10-year Treasury yields US10YT=RR were little changed, up 1 bp to 4.03%, while rate-sensitive 2-year yields US2YT=RR were flat at 3.53%.

"A rate cut is widely expected and is unlikely to drive the 10-year Treasury yield lower," Luca Cazzulani, head of strategy at UniCredit.

"First, significant easing is already priced in, and the bar for a dovish surprise from the central bank is high," he added.

Because of the size of the U.S. market, European bond yields can be affected by moves in Treasury.

Traders fully price in a 25 basis-point cut by the Fed and the focus will be on commentary from Fed Chair Jerome Powell and policymakers' updated economic and interest rate projections.

A dovish surprise from the Fed, meanwhile, could prompt U.S. Treasuries to outperform their German counterparts as investors have pared expectations of policy easing from the European Central Bank.

Money markets expect the Fed to lower policy rates by nearly 70 bps by the end of 2025, according to LSEG data. But they price in no rate cuts by the ECB this year.

Data released on Wednesday showed that month-on-month consumer inflation in the euro zone stood at 0.3% in August, in line with expectations.

The spotlight will also be on whether Fed policymakers considered an outsized 50 bps cut at a time when President Donald Trump has pressured them to cut rates further, casting a shadow over central bank independence.

On the longer end of the curve, German 30-year bond yields DE30YT=RR dropped 4 bps to 3.23%, after hitting the lowest level since August 14.

Germany's 30-year Bund auction also sailed through on Wednesday with an improved bid-to-cover ratio compared to the last auction, signalling strong appetite for the debt following recent pressure on long-dated bonds.

In Britain, Wednesday's data showed inflation held at 3.8% in August, in line with a Reuters poll, reinforcing market expectations that further rate cuts are unlikely soon.

The Bank of England is expected to keep rates unchanged on Thursday.

"Inline inflation print is unlikely to move the needle on the BoE's interest rates decision tomorrow," Emma Mogford, fund manager at Premier Miton Monthly Income Fund said.

Britain's 10-year gilt yield was flat at 4.63% GB10YT=RR.

Elsewhere, Norway's central bank, which meets on Thursday, is expected to lower rates by 25 bps.