July 17, 2018 / 7:16 AM / 4 months ago

Euro zone bond yields nudge down as spotlight turns to Powell

* Bond yields 0.5-2 bps lower on day

* Fed’s Powell kicks off 2-day testimony to Congress

* Germany sell 3 billion euros of 2-year bonds

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, July 17 (Reuters) - Euro zone government bond yields inched down on Tuesday, with trade largely subdued ahead of a testimony by Federal Reserve Chairman Jerome Powell to Congress.

Solid U.S. retail sales data on Monday had pushed U.S. and European bond yields higher as markets bet that a strong economy would keep the Fed on the path of raising interest rates.

But there was calmer tone to markets on Tuesday, reflecting a reluctance by investors to push yields any higher ahead of the first leg of Powell’s two-day testimony.

Powell is expected to express confidence in the U.S. economy and affirm the Fed’s gradual approach to raising short-term interest rates, while analysts said they will also be watching closely any comments on the impact of trade tensions and the marked flattening of the U.S. Treasury curve.

The Fed’s rate-hike campaign has stoked worries that short-term yields would eventually rise above long-dated yields, causing the yield curve to invert. An inverted yield curve has preceded the past five U.S. recessions.

“The main message will be that the Fed remains on course to hike rates further, which is discounted by markets,” said KBC rates strategist Mathias van der Jeugt.

“But if he steps up rhetoric on the downside risks stemming from a trade war, markets will start casting doubt on the rate hike trajectory.”

Ten-year bond yields across the euro area were down 0.5 to 2 basis points on the day, with southern European bonds outperforming.

Italy’s 10-year bond yield fell 2 bps to 2.56 percent , pushing the gap over German Bund yields to its tightest in almost four weeks.

Germany is scheduled to sell 3 billion euros of two-year government bonds on Tuesday in the first of this week’s hefty bond supply.

According to Commerzbank, supply from the euro zone issuers this week will total around 17 billion euros.

Reporting by Dhara Ranasinghe Editing by Robin Pomeroy

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