(Updates after US CPI at 1258 GMT)

By Harry Robertson and Samuel Indyk

LONDON, Aug 14 (Reuters) - Euro zone bond yields held

higher on Wednesday after U.S. consumer prices rose slightly in

July, supporting expectations for a quarter-point September rate

cut from the Federal Reserve but possibly not justifying a

larger move.

The consumer price index increased 0.2% last month after

falling 0.1% in June, the Labor Department's Bureau of Labor

Statistics said on Wednesday. In the 12 months through July, the

CPI increased 2.9% after advancing 3.0% the month before.

"It seems rather unlikely that the inflation figures will

materially alter the policy outlook, though the data does likely

help to provide officials with further confidence in the

disinflationary process," said Michael Brown, senior research

strategist at Pepperstone.

Germany's 10-year bond yield was up 2.5 basis

points (bps) at 2.207%, broadly in line with where it was before

the data. Yields move inversely to prices.

The benchmark German yield has fallen sharply from a roughly

six-month high of 2.707% in May as euro zone and U.S. inflation

has cooled, reassuring investors that further European Central

Bank rate cuts are coming this year.

The size and importance of the U.S. economy and dollar means

American data often moves bond yields and interest rate

expectations around the world.

"Today's U.S. inflation figure clears the runway for the

Federal Reserve to initiate a rate cut at its September

meeting," said Richard Carter, head of fixed interest research

at Quilter Cheviot.

"Where there is still a disconnect, as there was at the

beginning of the year, is in the expected pace of these rate

cuts," Carter added.

Interest rate futures are fully pricing a 25 bp cut from the

Fed in September, with around a 45% chance of a larger 50 bp

move.

Markets are also still pricing over 100 bps of easing by

year-end, implying at least a quarter-point rate cut at all

three meetings, including one outsized 50 bp cut, but Carter

thinks this may be too much.

"The economic picture is one of a weaker consumer and

businesses coming under pressure, but they remain stable enough

and as such rates will not come down quickly," he said.

Meanwhile, French inflation for July was revised slightly

higher to 2.7% year-on-year on Wednesday, putting a touch of

upward pressure on bond yields.

Italy's 10-year yield was up 2 bps at 3.59%, and

the gap between Italian and German bond yields was

steady at 138 bps.

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

sensitive to ECB rate expectations, rose 3 bps to 2.367%.

Bond yields have bounced around over the last week and a

half as fears about a slowdown in the U.S. labour market, and

the unwinding of some of this year's biggest equity and currency

trades, have injected volatility into financial markets.

Investors have, however, been reassured by cooler inflation

data, with bond yields falling and stocks rising on Tuesday

after U.S. producer price figures came in softer than expected.

Traders on Wednesday were expecting around 70 bps of further

interest rate cuts from the ECB this year, after a 25 bp

reduction to 3.75% in June, little changed from Monday and

Tuesday.