Euro zone bond yields dragged lower by U.S. Treasuries

By Medha Singh

May 16 (Reuters) - Euro zone government bond yields dropped on Friday, backing further away from multi-week highs hit earlier this week as U.S. economic data disappointed and risk appetite sparked by a de-escalation in the Sino-U.S. trade war faded.

German 10-year bond yields DE10YT=RR, the benchmark for the euro zone bloc, fell 4.6 basis points to 2.579%, but were still headed for their fourth consecutive weekly rise, reflecting the investor push away from debt. Bond yields move inversely to prices.

The United States announced trade deals with Britain and China this month, allaying fears of a recession caused by the trade war, which lessened demand for safe-haven assets that sent U.S. and euro zone yields to one-month highs this week.

However, a raft of soft data on Thursday indicated the world's largest economy slowed last month, which prompted traders to up their bets on interest rate cuts from the Federal Reserve and sent U.S. 10-year Treasury yields US10YT=TWEB 7 bps lower.

The yield on the U.S. 10-year Treasury bond was down 4.6 bps at 4.41% in Europe on Friday.

James Ringer, fund manager at Schroders, said many had anticipated that the market could shrug off weakness in April data given some resolution in trade tensions and the likelihood that much of the data had been gathered during the peak of market panic. However, Thursday's reaction showed the market was not willing to look past the data.

"How the U.S. data evolves over the next few weeks, in particular the hard data - jobless claims at the back end of the month, payrolls - that's going to be the most important," Ringer added.

Lately, money markets have priced in fewer interest rate cuts from the European Central Bank, expecting deposit facility rate to be at 1.72% by December compared with 1.65% expected on May 9 and 1.55% after the ECB suggested in mid-April it would cut rates in response to a possible tariff-induced economic slowdown.

ECB policymaker Martins Kazaks said on Friday rates may be close to bottoming out, but uncertainty was high and the environment was prone to sudden changes that could also alter the policy outlook.

Germany's two-year bond yield DE2YT=RR, which is more sensitive to European Central Bank rate expectations, was down 2.7 bps at 1.856%.

"It's a lot less about politics at the moment and a lot more on the fundamentals on growth, on inflation and what that means for the ECB," Ringer said.

Italy's 10-year yield IT10YT=RR fell 4.3 bps at 3.596%, and the gap between Italian and German bunds DE10IT10=RR narrowed slightly to 100.5 bps.