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Euro zone bonds ease slightly ahead of Fed Reserve meeting

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Germany's 10-year bond yield down nearly 4 basis points

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U.S. central bank expected to keep benchmark rate

unchanged

(Updates moves, adds context)

By Alun John

LONDON, June 18 (Reuters) - Euro zone bond yields eased

slightly on Wednesday with traders awaiting the outcome of the

Federal Reserve meeting later in the day for any hints about

further rate cuts, and keeping a wary eye on developments in the

Middle East.

Germany's 10-year bond yield was down nearly 4

basis points on the day at 2.497%, and its two-year yield was

down 1.6 bps at 1.85%.

The big event for markets around the world on Wednesday

is the Fed's rate decision, though the U.S. central bank is

widely expected to leave its benchmark overnight interest rate

in the 4.25%-4.50% range, where it has been since December.

Traders' focus will be on whether it gives any clues as to

if and when it might begin cutting rates again, though it is

also likely to repeat that it cannot give much guidance until

the impact of U.S. President Donald Trump's import tariffs and

fiscal policies becomes clearer.

Even an unlikely change in Fed messaging may do little to

nudge European government bonds out of their recent rangebound

trading, ING analysts said, as the economic effect of tariffs -

inflationary in the U.S., disinflationary in Europe - means Fed

and ECB policy is becoming more divergent.

Markets are currently pricing one final 25-basis-point ECB

rate cut this cycle to take its terminal rate to 1.75%,

expectations that have been fairly steady in recent weeks,

contributing to rangebound trading in government bonds.

Michiel Tukker, senior rates strategist at ING, said there

were two things that could change that.

"First is trade. July 9 is the date where we possibly have

trade tariffs kick in if there isn't a trade deal. That'll start

becoming a hot topic in the weeks before, and that's the period

we're rolling into," he said.

"Either negotiations turn sour, we go back to 1.5% (terminal

rate), or things go quite well and he (Trump) softens his

narrative and we maybe go closer to 2%, or at least stay near

1.75%, and the focus will shift back to German fiscal spending."

Germany is embarking on a massive ramp up of borrowing to

fund increased spending on infrastructure and defence, likely

leading to higher yields in the long term.

The other factor in the near term, according to Tukker, was

economic data, though it would require multiple data points to

detect a clear trend given the recent volatile trade policy.

"Each data point can tell a different story depending on the

sample month," he said.

Investors will also be looking at Wednesday's releases of

U.S. Treasury International Capital data that shows overseas

ownership of Treasuries.

There was much speculation this month that foreign investors

were looking to reduce their ownership of U.S. government bonds

due to erratic U.S. policy. Again, however, one data point will

not be enough to provide a clear picture.

U.S. Treasury

yields fell

on Wednesday as concerns over the war in Iran boosted

safe-haven demand for the debt.

Other bonds in Europe were largely moving in line with

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

euro zone periphery, was down 3 bps at 3.48%.