Euro zone bond yields dip after Fed chair Powell hints at September cut

By Joice Alves and Alun John

LONDON, Aug 22 (Reuters) - Euro zone bond yields dropped on Friday, echoing a larger move in Treasuries after U.S. Federal Reserve Chair Jerome Powell pointed to a possible rate cut at the central bank's September meeting but stopped short of committing to doing so.

The German 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, was last down 3 basis points at 2.72%, extending an earlier fall following the remarks.

Powell’s comments open the door to a rate cut at the Fed’s September 16-17 meeting. While Powell put heavy weight on jobs and inflation reports that will be received before then, analysts said the Fed chair appeared to put greater weight on the former.

"Obviously, Powell was more dovish than the market expected, but he is responding to the weakening of the labour market, recognising the risks there," said Jay Hatfield, chief executive officer, Infrastructure Capital Management.

This "sets us up for a September cut," he said.

U.S. yields fell much more dramatically than European. The rate-sensitive two-year Treasury yield US2YT=RR fell 10 bps to 3.69%, with the benchmark 10-year yield down 6 bps at 4.27%. US10YT=RR US/

Because of the size and importance of the U.S. economy, changes in expectations over the Fed's moves on interest rates often influence other bond markets.

However, with the European Central Bank likely to hold interest rates steady for the rest of this year, European rates, particularly shorter dated ones, saw a fairly muted reaction to U.S. moves.

Germany's ECB-sensitive 2-year yield was down 2 bps at 1.95%. DE2YT=RR

Other European bond yields also dropped and Italy's 10-year yield shed 5 bps to 3.56%. IT10YT=RR

That helped push the gap between Italian and German 10-year yields to 83 bps, continuing its relentless tightening.

The gap between French and Italian yields was just 14 basis points as Italian yields move ever closer to falling below French ones. FR10IT10=RR

"The strong buying momentum and a benign environment for risky assets could result in further (Italian) BTP performance," said analysts at Societe Generale.

"Rating actions from Fitch could see France downgraded and Italy upgraded, while French politics could remain volatile into year-end."