(Updates with afternoon trading)

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German bond yields fall slightly

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Treasury yields also lower

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Germany's fiscal expansion may soon impact growth,

inflation

By Samuel Indyk

LONDON, Oct 21 (Reuters) - Euro zone government bond

yields dropped on Tuesday, moving in line with U.S. Treasuries

and resuming last week's trend begun by market jitters about

U.S. credit and bets on further Federal Reserve easing.

Germany's 10-year bond yield was down 3 basis

points (bp) at 2.55%, closing in on Friday's four-month low of

2.52%.

The yield on the euro zone benchmark fell for a fourth straight

week last week as investors sought safe-haven assets due to

concerns about the U.S. government shutdown, the trade spat with

China and signs of U.S. credit stress. Bond yields move

inversely to prices.

The 10-year U.S. Treasury yield was also down around 3 bps

at 3.96%, likewise closing in on Friday's 3.93%.

"Looking for lower market rates is the simplest

interpretation of the wider backdrop," said analysts at ING in a

note.

They added that European rates seemed more sensitive to

global factors than local political risks at present.

ECB IN 'GOOD PLACE'

Bond investors around the world are waiting for delayed U.S.

inflation data due on Friday, the only major piece of U.S.

economic data to be released during the long-running U.S.

government shutdown.

The Federal Reserve then meets next week and markets

currently see it as all-but-certain to cut rates by 25 basis

points, and then do so again in December.

Meanwhile in the euro zone, inflation is close to target and

growth somewhat resilient. ECB President Christine Lagarde has

repeatedly said the bank is in a "good place", suggesting no

need to take policy action in coming meetings.

Futures markets imply that the central bank will keep its

policy rates on hold for the remainder of the year, and that

there is an 80% chance of another quarter-point rate cut through

2026.

"We need to see how the fiscal expansion in Germany is going

to affect prices and economic activity," said Rene Albrecht,

analyst at DZ Bank.

"We will probably see a positive impact on growth and price

pressures in the second half of 2026."

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

changes in interest rate expectations, was little changed at

1.91%.

Concerns about fiscal sustainability in countries such as

the U.S., Japan and France also lingered.

The French sovereign was unexpectedly downgraded by S&P to

'A+/A-1' from 'AA-/A-1+' on Friday, a warning that political

instability puts the government's efforts to repair its finances

at risk.

France's 10-year yield was down 2 bps at 3.34%,

keeping the spread over the 10-year German yield

steady at about 79 bps.