(Updates at 1500 GMT)

By Stefano Rebaudo

Sept 27 (Reuters) - Euro zone government bond yields

dropped on Friday after inflation data from France and Spain led

investors to increase their bets on future European Central Bank

interest rate cuts.

Softer than expected U.S. inflation data added to the mood,

pushing European yields down a little further.

French consumer prices rose less than anticipated in

September, aided by a decline in energy costs. Spain's European

Union-harmonised 12-month inflation eased to 1.7%, lower than

the 1.9% expected by analysts polled by Reuters.

The German and euro area figures are due next week.

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

the euro zone bloc, fell 3 basis points to 2.14%, and Germany's

two-year bond yield was last down 2 bps at 2.09%. It

hit 2.065%, its lowest level since December 2022, earlier in the

session.

The declines came as money markets priced in an 80% chance

of an ECB rate cut in October from around

20% early this week and 60% before data.

They are inclined to discount a bigger move in December as

forwards on the ECB euro short-term rate (ESTR)

fully discounted a 50 bps cut by year-end.

Major banks including Goldman Sachs and JPMorgan on Friday

also revised their ECB rate path forecasts to include a cut in

October.

"This week's data have sufficiently moved the needle," Greg

Fuzesi, euro area economist at JPMorgan, said in a note

explaining their call change.

Fuzesi said this week's PMI data "disappointed

significantly" and "the early hints from today's French and

Spanish CPI reports is also that core inflation may be edging

lower."

Purchasing Managers Index survey data released Monday showed

euro zone business activity contracted sharply and unexpectedly

this month.

Also in the mix for markets, Friday data showed U.S.

inflation pressures continued to abate.

The personal consumption expenditures price index rose 0.1%

month-on-month in August, in line with expectations, and 2.2%

year-on-year, the smallest such gain since February 2021 and

down from 2.5% in July.

The U.S. central bank tracks the PCE price measures for its

2% inflation target.

U.S. yields and European yields moved slightly lower

immediately after the data.

The gap between French and German 10-year yields

- a gauge of risk premium that investors demand to

hold France's government bonds - was last at 79 bps, up from

around 70 bps two weeks ago.

It reached its widest since 2012 during France's

parliamentary election earlier this year, at beyond 85 bps.

French Budget Minister Laurent Saint-Martin said the deficit

was at risk of topping 6% of economic output, far above the 5.1%

that the previous government had estimated in the spring.

He added that the government would focus a budget squeeze on

spending cuts first and then tax increases, amid calls for a

realistic plan to rein in a fiscal shortfall which threatens

France's credibility with financial markets.

Italy's 10-year yield fell 2 bps to 3.46% and

the gap between Italian and German yields was 131

bps.