November 23, 2018 / 9:04 AM / 23 days ago

UPDATE 4-German 10-year bond yield tumble to lowest since Sept on weak euro zone PMI

* Bond yields fall after weak PMI data

* German Bund yields at lowest since early Sept

* ECB rate-hike expectations scaled back further

* Italy bonds poised for its best week since Sept on price jump

* EU affairs minister Savona denies reports he may quit

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates pricing)

By Dhara Ranasinghe

LONDON, Nov 23 (Reuters) - Germany’s 10-year bond yield fell to its lowest since early September on Friday as weak business activity data for the bloc fanned concerns about the growth outlook, prompting a further scaling back of ECB rate-hike expectations.

Italy’s bond yields drifted up after Italian Deputy Prime Minister Matteo Salvini and EU Affairs Minister Paolo Savona denied reports that Savona was considering resigning. Those reports had boosted Italian bond prices at the open, pushing yields down as much as 12 basis points.

But it was the turn of economic data to take over as key focus for debt markets.

IHS Markit’s Flash Composite Purchasing Managers’ Index for the euro zone fell to 52.4 in November, its lowest since late 2014. That triggered buying across euro zone bond markets, while the euro weakened.

“The big picture is that the data is not bad enough for the ECB to not end asset purchases at the end of the year,” said Jack Allen, senior European economist at Capital Economics.

“But if growth fails to rebound, they (ECB policymakers) will have to think twice about raising rates next year.”

Germany’s benchmark 10-year Bund yield fell by over 3 basis points to 0.332 percent, its lowest level since early September. Other 10-year bond yields in the bloc fell as much as four bps as investors bet that weak economic data would encourage the ECB to leave rates lower for longer.

U.S. Treasury yields meanwhile fell to their lowest since late September.

Money market pricing suggests investors now price in around a 90 percent chance of a 10 basis point increase in the ECB’s deposit rate by the end of 2019, down from 100 percent at the start of the week.

In addition, a key market gauge of long-term euro zone inflation expectations fell to its lowest level in over a year to 1.6326 percent.

VOLATILE ITALY

In Italy, bond yields drifted higher after Savona denied the reports he was considering his resignation.

Analysts said markets had been cheered by a press report early on Friday that raised the prospect of his resignation because Savona is known for his euroscepticism.

Savona became EU affairs minister earlier this year after Italy’s president rejected his nomination by the now ruling coalition as economy minister, a move that prompted a political crisis and a rout in bond markets. “The market’s take is simplistic. There is a European sceptic in the government - if he goes, then happy days,” said Peter Schaffrik, global macro strategist at RBC Capital Markets.

Two-year Italian bond yields were down 6 bps at 0.96 percent , off two-month lows hit earlier in the session but still set for the biggest weekly drop since early September.

They have fallen almost 40 bps this week.

The bulk of that move came after Wednesday, when the European Commission formally moved towards disciplinary action against Italy over its expansionary budget.

Sentiment towards battered Italian bonds has turned positive this week, a change analysts put down to a number of factors.

These include a sense that any disciplinary action the EU takes against Italy will take some time and with bad news heavily priced into bonds, current price levels look attractive.

Also, some positive noises from both Italian and EU officials have raised some hopes of a compromise being reached.

Reporting by Dhara Ranasinghe; Additional reporting by Giselda Vagnoni in ROME; Editing by Patrick Johnston and Gareth Jones

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