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LONDON (Reuters) - Euro zone bond yields fell on Tuesday as below-forecast data from major economies and talk about extraordinary ECB monetary easing measures overshadowed worries about a turnaround in Federal Reserve policy.
Bond yields in many euro zone countries have almost completely reversed last week's rise of up to 10 basis points triggered after Fed chair Janet Yellen's surprising signal that the United States could raise interest rates sooner than many had expected.
A fall in the German Ifo business sentiment index on Tuesday and weaker-than-expected manufacturing data out of Germany and the United States on Monday were the main drivers behind the correction, analysts said.
Bund yields, the benchmark for euro zone borrowing costs, fell 1.5 basis points to 1.574 percent, having risen to as high as 1.669 percent after Yellen's remarks last week. Most other bond yields in the single currency area fell 1-2 basis points on the day.
Short-dated U.S. yields remained close to their post-Yellen highs, however, in a sign that markets are not dismissing her warning about the timing of the move on rates.
Analysts said flatter yield curves meant only that investors now expected rates to rise more slowly than they had initially feared, because recent data suggested the U.S. recovery still had not reached full speed.
"We've had signs that the global economy may be facing some headwinds," said Elwin de Groot, rate strategist at Rabobank in Utrecht. "A scenario in which the Fed starts easing earlier than expected as Yellen said, but does that at a slower pace would make sense if you look at the current moves in yields."
Yellen said the Fed would probably end its massive bond-buying stimulus programme this autumn and may start raising rates six months later.
"People got short after Yellen and we see some short-squeezing ... (because) maybe the risk is that the Fed will try to tone down the message," one trader in London said.
Short positions are market jargon for bets that the price of an asset will fall.
European Central Bank policymaker Jens Weidmann told MNI that the bank could buy loans and other assets from banks to lift the euro zone economy and that negative interest rates would help counter a higher exchange rate.
His comments did not have an immediate impact on the market, but speculation that the ECB might ease monetary policy further has been a key driver behind this year's rally in euro zone government bonds, particularly the lower-rated ones.
ECB easing would keep yields on top-rated bonds at ultra-low levels and prompt many investors to buy riskier assets to maximize their returns.
"Peripheral Europe remains very resilient, the search for carry is still driving the market," said Jan von Gerich, chief fixed income analyst at Nordea in Helsinki.
Spanish and Italian 10-year yields both fell 2 bps to 3.34 percent and 3.40 percent, respectively. Portuguese yields were at 4.27 percent, slightly off a recent four-year low of 4.188 percent.
Editing by Susan Fenton