By Stefano Rebaudo

July 17 (Reuters) -

Euro area government bond yields edged lower on Thursday,

tracking U.S. Treasuries, amid concerns over the potential

dismissal of Federal Reserve Chair Jerome Powell.

U.S. President Donald Trump said on Wednesday he was not

planning to fire Powell, but kept the door open to the

possibility and renewed his criticism of the central bank chief

for not lowering interest rates.

Analysts said that if Powell were ousted under Trump's

pressure, short-dated yields could fall on expectations of

looser monetary policy. In contrast, long-dated yields would

rise as a less independent Fed would be seen as less credible in

fighting inflation.

Powell's current term is set to end in May 2026.

Germany's 10-year government bond yield , the

euro area's benchmark, dropped 2 basis points (bps) to 2.67%.

The 2-year yield - more sensitive to expectations for policy

rates - was flat at 1.83%.

U.S. Treasury yields edged lower on Thursday, briefly

spiking after a batch of data showed the world's largest economy

remained on a stable footing.

"A deepening in interest rate cut expectations would filter

directly into the front end of the curve," said Padhraic Garvey,

regional head of research, Americas, regarding the impact of

Powell leaving before his term.

The long-end of the curve will be questioning the risks

being added to inflation, he argued.

Elevated fiscal deficits and upward pressure on consumer

prices from tariffs have already unsettled investors.

Bottom line, market participants should expect a much

steeper curve, which happens when the gap between long-dated and

short-dated yields widens.

French 10-year yield was down 1.5 bps at 3.38%.

The gap between French and German yields - a

market gauge of the risk premium investors demand to hold French

debt - was at 70.5 bps.

Investors are focusing on the French budget approval

process, after Prime Minister Francois Bayrou proposed a 43.8

billion euro squeeze on Tuesday, which left-wing and far-right

politicians immediately criticised.

Any risk of a no-confidence motion would likely intensify

once a detailed budget bill is presented to parliament in

October, potentially prompting a widening of the yield spread.

"Maintaining this deficit target could add to political risk

premium for coming months with 10-year OAT-Bund spread

potentially reaching 80-85bp," said Aman Bansal, director

European rate strategy at Citi.

"This would likely reverse only if the government succeeds

in getting the budget approved, in which case the OAT-Bund

spread could decline to 60 bps as the 5.3% consensus for the

deficit is surprised to the downside."

Italy's 10-year government bond yields fell 2

bps to 3.56%, with the spread between BTPs and Bund yields at 88

bps. It hit 84.20 bps earlier this month, its lowest level since

March 2015.