(Updated at 1017 GMT)

By Samuel Indyk and Sruthi Shankar

LONDON, Aug 15 (Reuters) -

Euro zone bonds yields steadied as investors awaited more

U.S. economic data after mild readings of U.S. inflation this

week cleared the way for the Federal Reserve to cut interest

rates next month.

Germany's 10-year bond yield, the benchmark for

the euro zone, firmed 1.4 basis points (bps) to 2.191% after

falling in recent days. Bond yields move inversely with prices.

Euro zone yields have fallen sharply from multi-month highs

in May as weaker-than-expected U.S. payrolls data earlier this

month and signs of easing inflation in the United States and

Europe opened the door for policy easing this year.

Investors will keep a close on U.S. weekly jobless claims

and retail sales data at 1230 GMT (8:30 a.m. ET) for more hints

on the U.S. economy's health and monetary outlook. Tame U.S.

inflation data in recent days has reinforced bets of rate cuts

from the U.S. central bank.

"Overall, the narrative of disinflationary environment is

very much relevant but the market should be very cautious not to

extrapolate the process," said Michel Vernier, head of fixed

income strategy at Barclays Private Bank.

"While we've seen fairly encouraging inflation data on the

core side, it has not shown a big disinflationary trend. We may

see a bit of a consolidation in the rate market in the coming

weeks."

Money markets show traders are expecting an overall 103 bps

of rate cuts from the Fed this year, with the odds of a 25 bp

rate cut in September at 65%.

Traders meanwhile have fully priced in a 25 bp rate cut by

the European Central Bank next month, after a quarter-point rate

cut in June to 3.75%.

Volatility has gripped U.S. and European bond markets in

recent weeks as concerns about a slowing U.S. economy and an

unravelling of this year's most popular trades drove investors

into safe-haven bonds and out of risky equities.

"After the moves that we've seen (in early August) and

without evidence of the euro zone going into a recession, we see

euro rate levels a little bit rich at this point," added

Vernier.

Germany's two-year yield, which is more sensitive

to changes in interest rate expectations, was up 1.2 bps at

2.36%.

Italy's 10-year yield added 0.6 bps at 3.57%,

with the closely watched spread between Italian and German

10-year yields narrowing 1.1 bps at 137.2 bps.