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UPDATE 2-Euro zone bond yields plunge on declining risk appetite

(Recasts, adds background)

June 22 (Reuters) - Euro zone government bond yields fell sharply on Wednesday with investors grabbing safe-haven assets as risk appetite falls amid persistent worries about the economic outlook.

World stock markets and oil prices slumped on concern over rising interest rates and the threat of recessions.

Germany’s 10-year government bond yield, the bloc’s benchmark, fell 16 basis points (bps) in its biggest daily fall since March 1. It hit a one-week low at 1.595%.

“Today’s UK inflation data fed into this story about inflation, central banks being more restrictive, and recession fears,” Wolfgang Bauer, fund manager at M&G Investments said.

Soaring food prices pushed British consumer price inflation to a 40-year high of 9.1% last month.

Federal Reserve Chair Jerome Powell’s statement before the U.S. Senate Banking Committee reiterating that the Fed is “strongly committed” to bringing down inflation had no effect on the price action in the euro area.

Italy’s 10-year bond yield fell 18 bps to 3.6%, with the spread between Italian and German 10-year borrowing costs back below the 200 bps threshold after widening up to 207.9 bps earlier in the session.

Investors’ focus shifted to the European Central Bank’s announcement last week of a planned tool to prevent an excessive divergence in borrowing costs across the euro area, and analysts said this would make it easier for the ECB to tighten its monetary policy.

“The impression thus thickens that they (ECB’s doves) could aim for a gentlemen’s agreement, offering higher rates in return for more profound changes to the ECB’s role in the monetary union,” Commerzbank analysts said in a note to clients.

ECB Vice President Luis de Guindos said on Wednesday the tool to combat rising government debt yields in some euro zone countries should not interfere with the bank’s aim to control inflation.

Italian Foreign Minister Luigi Di Maio said he was leaving the 5-Star Movement to form a new parliamentary group backing the government, which could lead to concern about Prime Minister Mario Draghi’s coalition, although some analysts said they saw little lasting impact from the move.

“This move might trigger a bit of volatility, but I don’t think it will weigh much with the (Italian-German) spread at the current levels,” said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

“At the moment, I don’t see any consequences for the stability of the Draghi government,” he added.

Meanwhile, French President Emmanuel Macron lost control of the National Assembly in legislative elections on Sunday.

“Political risks are a bit under the radar despite French elections and the risk of Giuseppe Conte (leader of the 5-Star Movement) leaving the ruling coalition in Italy. A potential shift towards no-firm believers in the euro zone is currently underpriced,” M&G Investments’ Bauer said. (Reporting by Stefano Rebaudo, Editing by Hugh Lawson)

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