UPDATE 1-Euro zone bond yields fall on Fed rate cut talk, renewed global risks

Euro area government bond yields tumbled on Wednesday after comments by U.S. Federal Reserve officials reinforced expectations they would cut interest rates this month and suggested they are debating how deep that cut should be.

Comments from U.S. President Donald Trump that the United States still has a long way to go to conclude a trade deal with China, and growing concern about a no-deal Brexit, added to a sense of renewed uncertainty in world markets. Having risen last week as investors booked profits on hefty bond price gains, yields headed back towards recent record lows.

French 10-year bond yields fell 4 basis points to minus 0.03%, moving towards record lows hit in early July at around minus 0.14%. Across the euro zone, 10-year bond yields were down 2-4 bps, with German Bund yields at minus 0.28%.

Chicago Federal Reserve President Charles Evans said on Tuesday that an interest rate cut of half a percentage point this month could ensure the Fed meets its inflation goal sooner. Dallas Fed President Robert Kaplan, until recently a sceptic that rates should be cut at all, said he now thinks a "tactical" reduction of a quarter point could address the risks apparently seen by bond investors, who have pushed some long-term yields below shorter-term ones.

"It is very likely that we will get a rate cut in July and now the discussion is about whether we get a 25 or 50 bps cut," said Daniel Lenz, a rates strategist at DZ Bank. Fed Chair Jerome Powell on Tuesday reiterated a pledge to "act as appropriate" to keep the U.S. economy humming, validating expectations that a rate cut is coming.

Heightened expectations of U.S. monetary easing have fuelled expectations the European Central Bank will cut rates in September to boost inflation and protect the economy from a global trade war. ECB board member Benoit Coeure said on Wednesday that the Governing Council was ready to act if necessary to help inflation move towards its near 2% target.

The ECB meets next week and is expected to flag fresh easing measures just seven months after ending quantitative easing. This speculation, together with negative yields in higher-rated bond markets such as Germany and an easing in tensions between Italy and the EU over Rome's fiscal policies, have boosted Italian bonds this month.

The Italian/German 10-year bond yield gap is close to its tightest in over a year at around 185 bps, while two-year Italian bond yields are back in negative territory . "Italy is under-owned by many international investors," said Marco Meijer, senior interest rate strategist at BNP Paribas.

"The window to have snap elections this year is closing fast. With no major news expected until the 2020 Budget Law discussions starting in October, the carry on offer on Italy is probably too good to resist over the summer," he added.

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