(Updates with morning European trading)

By Alun John

LONDON, Oct 8 (Reuters) - Euro zone bond yields edged

lower on Wednesday, with French bonds outperforming marginally

on the possibility that the country's parliament may agree a

budget by the end of the year.

The mood was much calmer than earlier in the week when

developments in French and Japanese politics sent yields higher

worldwide, but with bond markets having been under pressure for

much of the year the calm is unlikely to last.

The main news of the European morning was caretaker French

Prime Minister Sebastien Lecornu striking a cautiously

optimistic tone and saying that a deal could potentially be

reached on the country's budget by year-end, making the

possibility of a snap election less likely.

That helped send the yield on France's 10-year bond lower,

and it was last down 5 basis points on the day at 3.52%. It had

traded close to 3.6% on Monday and Tuesday after the resignation

of Lecornu, France's fifth prime minister in less than two

years.

Germany's 10-year yield was down 3 bps at 2.68%,

leaving the gap between French and German yields at 83 bps down

from nearly 88 bps on Monday.

The gap, the premium investors require to lend to France

rather than Germany, remains elevated and is among the highest

in the euro zone.

And analysts were wary of getting too excited about

Wednesday's move in French yields.

"I suspect there is some short covering going on but it

doesn't really change the context," said Kenneth Broux, head of

corporate research FX and rates at Societe Generale, pointing to

France's large deficit.

"The risk premium in OATs (French government bonds) may be

here to stay for a while."

Lecornu is due to speak again later in the day, though the

leader of France's Socialist Party said they could not back the

government's budget plan as it currently stands.

France aside, there was little else for euro zone bond

investors to process.

Data showed German industrial output fell much more than

expected in August due to a sharp decrease in production in the

car industry. But with the European Central Bank seemingly

firmly on hold for now, it would take a lot more bad economic

news to raise bets on a further rate cut this year.

Germany's rate-sensitive two-year yield dipped 1 basis point

to 1.99%.

Earlier in the day, Japanese government bonds were also

calmer following a tumultuous few days as speculation swirled

about the course of the country's fiscal policy.

Still to come on Wednesday is the release of minutes of the

latest meeting of the U.S. Federal Reserve's rate setting

committee. It would not typically be market moving, though due

to the U.S. shutdown causing an absence of major economic data,

the minutes could take on greater significance.