(Updates at 1450 GMT)

By Alun John

LONDON, July 11 (Reuters) - Euro zone bond yields

dropped sharply on Thursday, mirroring a fall in Treasuries

after data showed U.S. consumer inflation unexpectedly fell in

June, drawing the Federal Reserve another step closer to cutting

interest rates.

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

the euro zone bloc, was down 7 basis points bps at 2.47%, having

been broadly flat before the data.

The U.S. consumer price index dipped 0.1% last month after

being unchanged in May, the Labor Department's Bureau of Labor

Statistics said on Thursday, and rose 3.0% year on year.

Markets moved to all but price in a Federal Reserve rate cut

in September after the data, and U.S. 10 year Treasury yields

dropped around 10 bps to 4.18%.

"(Fed chair Jerome) Powell spent the past two weeks

emphasizing they (the Fed) are data driven. And I'm going to

take him at his word, said Kim Forrest, chief investment

officer, Bokeh Capital Partners.

"Certainly, another month of this (data) gives them the

ability to cut rates in the September meeting."

The European Central Bank cut its main rates by 25 basis

points in June, and markets currently see two more such moves

are more likely than not by year end, with around an 80% chance

of another move in September.

European bonds typically react to U.S. price data both

because of what it says about the inflation picture and because

analysts say the ECB would not wish to diverge too substantially

in policy from the Fed.

Most European bonds moved in lockstep, and France's 10-year

yield was also down around 6 bps at 3.12%, leaving the gap

between French and German 10 year yields at 65 bps.

That gap is a now closely watched gauge of French risk and

reached its widest since 2012 in late June at 85 bps as

investors feared France's parliamentary election would lead to a

majority for high-spending parties, instead of the legislative

gridlock that actually resulted.

Italy's 10-year yield was down 8 bps at 3.79%,

its lowest since March.

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

sensitive to European Central Bank rate expectations, was down 9

bps at 2.81%.