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Euro zone government bond yields drop on weak PMI data

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By Stefano Rebaudo

June 21 (Reuters) -Euro zone government bond yields dropped on Friday after French and German economic survey data came in weaker than expected, supporting expectations for policy rate cuts.

Weak demand dragged dragged down France's business activity as the country heads into a snap parliamentary election, while an upturn in Germany slowed in June.

Euro area business growth decelerated sharply this month as demand fell for the first time since February.

Surveys "suggest a solid recovery in the euro zone economy is not a done deal", said Franziska Palmas, senior European economist at Capital Economics.

"Meanwhile, aggregate price pressures continued to ease but remained strong in the services sector, which will keep ECB policymakers cautious," she added.

Money markets price in cumulative around 68 bps of European Central Bank rate cuts by year-end EURESTECBM4X5=ICAP from 65 bps before PMI data, implying a further move and a 70% chance of a third cut in 2024.

Bund yields were on track for a slight weekly rise, as hopes that France's far right National Rally (RN) party will backtrack on fiscally expensive pledges stopped last week's rush into safe-haven assets.

German 10-year bond yields DE10YT=RR, the benchmark for the euro area, fell 4.5 basis points to 2.38% and were set to end the week 2 bps higher.

The gap between French and German 10-year yields DE10FR10=RR - a gauge of risk premium investors demand to hold French government bonds – was at 72 bps, after hitting 82.34 bps last Friday, its highest level since February 2017.

"OATs (French government bonds) look priced for a hung parliament/RN-lead with a benign fiscal outcome but might widen sharply to 100 bps over Bunds on a more forceful far-right/left manifesto implementation, while tightening to 60 bps on a centrist coalition," Citi analysts said.

France's 10-year yields FR10YT=RR fell 3.5 bps to 3.12%.

RN is seen leading the first round of the country's parliamentary elections with 35% of the votes, according to a survey released on Thursday. President Emmanuel Macron's centrist camp was in third place with 20% of the votes.

Market sentiment towards France and the euro area's most indebted countries improved on Thursday as the market got through a French bond auction largely unscathed.

However, on top of that, there were hopes of monetary easing ahead after the Swiss National Bank marginally surprised markets by cutting rates, and the Bank of England delivered a dovish message, analysts said.

Italy's 10-year yield IT10YT=RR remained at 3.916%, while the Italian-German yield gap stood at DE10IT10=RR 152 bps.

Reporting by Stefano Rebaudo, editing by Alex Richardson


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