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Japanese auction lifts sentiment

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May EZ inflation comes in cool

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Markets look ahead to Thursday's ECB meeting

(Updates latest price moves, adds quotes, news context

throughout)

By Lucy Raitano

LONDON, June 3 (Reuters) - Long-dated euro zone

government bond yields fell on Tuesday, as slowing euro zone

inflation buoyed expectations for a European Central Bank rate

cut this week, while a strong Japanese auction earlier lifted

sentiment across big bond markets.

German 10-year bond yields were last down 2 bps to

2.505%, having earlier hit their lowest level since May 8.

Elsewhere, Italian 10-year bond yields fell to

three-month lows at around 3.48%, as did French

yields, which touched 3.15%.

Data on Tuesday showed consumer price inflation in the

20 countries sharing the euro

slowed to 1.9%

in May from 2.2% a month earlier, dipping below the ECB's

2% target.

The figures came in below expectations for 2.0% on a

fall in energy prices and a sharp decline in services inflation.

The data bolsters bets on a rate cut at the ECB's next

meeting on Thursday.

Traders are currently placing a 95% chance on a 25-bp

cut on Thursday, which would be its eighth cut since last June

to the bank rate, currently at 2.25%.

"...like many among us the ECB is trying to make sense

of the trade negotiations with the U.S. - where do we land, what

does it mean for inflation and growth?" said Kenneth Broux, head

of corporate research FX and rates at Societe Generale.

He said that bonds have been in limbo amid few answers,

a data-dependent outlook and no pre-commitment from the central

bank. In addition, a stronger euro helps offset some of the

impact of higher inflation on the economy.

Analysts said positive sentiment in European debt markets on

Tuesday, where the fall in yields implied a rise in prices, was

supported by a strong government bond auction in Japan.

Recent tepid auction results for longer-dated debt in the

United States and Japan have raised concerns about the ability

of major economies to sell their bonds against a backdrop of

concern about high debt levels.

On Tuesday 10-year Japanese government bond (JGB) yields

fell after results of an auction of the securities saw the

highest demand since April last year.

U.S. Treasuries outperformed on Tuesday, falling 4 bps to

4.4181%. Markets were awaiting key U.S. employment

data due later in the session.