EURO GOVT-Two-yr yields mark new lows with rate cuts eyed

* Schatz yield hits new 3-yr low as rate cuts eyed

* UK and US inflation ease at record rate

* Three-month dollar Libor rates resume easing

* Greek debt auction meets with strong demand

By Kirsten Donovan

LONDON, Nov 18 (Reuters) - Short-dated euro zone government bonds marked new three-year lows on Tuesday on firming expectations for further interest rate cuts as investors fretted over an accelerating global slowdown.

Bunds remained well bid through most of the session as the flow of grim news continued with major world banks showing renewed strain from the economic crisis on Tuesday [ID:nLI346084].

However, a late equity rally took some of the shine off the market, with yields ending the day little changed.

Two-year yields EU2YT=RR fell as far as 2.128 percent, and were last at flat on the day at 2.185 percent, while 10-year Bund yields EU10YT=RR were again testing the key 3.65 percent area at 3.654 percent.

The two-year yield has fallen more than 100 basis points over the past month, leaving it close to a historic low just above 2.00 percent plumbed in June 2005.

"It's still the front-end that's marking new lows, the 10-year is finding the 3.65 percent barrier a struggle to get through," said Calyon rate strategist David Keeble.

"But the steepening trade is still very much in vogue and likely to remain so for now. The world isn't changing very rapidly, it's sliding into a hole and will stay there for a few more months."

The 2-10-year yield curve remained close to its steepest in 4-years at around 146 basis points.

Meanwhile, the Bund future FGBLc1 hit its highest since early 1996 at 119.03 on a continuous contract basis and was last flat on the day at 118.75.

The 10-year swap spread widened further to around 58 basis points as bonds outperformed rates, in contrast to the U.S. where the equivalent spread is narrowing.

"For now it looks like Europe is ignoring the extra supply that's likely to come through on to the cash (bond) curve," Keeble added.

FOCUS TURNS TO TRICHET

With a relatively thin data calendar, the focus fell on comments from officials including Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, who reiterated the need to preserve funds earmarked for the financial bailout [ID:nWEQ000393].

Attention now turns to European Central Bank President Jean-Claude Trichet, whose speech after the market closes will be scrutinised for hints on how aggressively the bank will cut rates in December.

The ECB has cut rates by 100 basis points to 3.25 percent since early October and the market is expecting at least another 50 basis point cut at the December meeting when bank staff will update their growth and inflation projections. [ECB/INT]

Meanwhile, signs that inflationary pressures are receding -- British consumer prices posted their biggest drop since records began and U.S. producer prices declined by a record 2.8 percent in October -- mean that central banks will have more room to ease monetary policy [ID:nLI422016].

In money markets three-month dollar Libor rates USD3MFSR= eased at Tuesday's fixing, after posting three days of rises on the back of concerns over comments from Henry Paulson regarding the use of the U.S. bailout funds.

Strategists said the levelling off in rates after the rise of recent days reflected the increasing closeness of the next Federal Reserve meeting, where rates are seen falling, but added that liquidity conditions were worsening.

"Lending on the dollar side is starting to dry up ahead of the end of the year and there are very few lenders coming into the market," said Calyon's Keeble.

"It's near enough the end of the year for some of the American banks, there are concerns and cash is being hoarded despite the TARP and the Fed's actions. If you look at the equity performance of the banks, there is really still not much to be happy about."

Greece sold 1.3 billion euros of reopened 3.8 pct March 2011 bonds on Tuesday, in an auction which met with strong demand after spreads over equivalent German bonds widened sharply in recent weeks.