Euro zone bond yields steady, rate cut expectations little changed

LONDON, Aug 7 (Reuters) - Euro zone bond yields struggled for direction on Thursday after rising slightly in the previous session, with investors focusing on the outlook for monetary policy and supply from France and Spain.

Any drama for euro zone markets is likely to come from outside the bloc, with the Bank of England announcing its interest rate decision at 1100 GMT, while pricing for the Fed has been volatile.

Things in Europe have been quieter this week, and Germany's 10-year bond yield DE10YT=RR, the euro zone's benchmark, was up less than 1 basis point at 2.651%, within its recent tight range. It is around 3 bps lower on the week.

"Summer illiquidity has set in and in the absence of any major drivers, the market is lacking direction," Jefferies economist Mohit Kumar said in a note.

Germany's two-year yield DE2YT=RR, which is more sensitive to changes in interest rate policy, was little changed at 1.9134%.

Market pricing for European Central Bank rate cuts remains little changed. Investors are only pricing in a 12% chance of a cut at next month's meeting, with about a 90% chance they cut rates by March.

In contrast, markets have recently added to bets for rate cuts from the U.S. Federal Reserve after soft jobs data for July, while the Bank of England is expected to lower borrowing costs when it announces policy later on Thursday.

Futures markets are now almost fully pricing in a rate cut from the Fed next month, with 60 bps of easing priced by the year-end, implying two quarter-point cuts and a 40% chance of a third.

In the aftermath of that soft U.S. jobs data, and the resulting rally in U.S. Treasuries, the gap between German and U.S. yields reached its tightest in three months. It was last slightly wider again at 159 bps. DE10US10=RR

Investors were also processing decent bond auctions from France and Spain, both of which saw strong demand.

French, Spanish and Italian bonds were all largely moving in line with the German benchmark, and were all flat on the day.

France's 10-year yield was 3.31%, Spain's was 3.22% and Italy's 3.47%. FR10YT=RR, IT10YT=RR, ES10YT=RR

($1 = 0.8564 euros)