UPDATE 1-Euro zone yields mixed as data supports September monetary easing

Recasts lead, adds comments, background

By Stefano Rebaudo and Sruthi Shankar

Aug 30 (Reuters) - Euro zone government bond yields struggled for direction on Friday after inflation data on both sides of the Atlantic supported expectations for an interest rate cut in September.

Data showed consumer price growth in the 20 countries sharing the euro slowed to 2.2% from 2.6%, in line with expectations and closer to the European Central Bank's 2% target after three years of above-target price growth.

Federal Reserve policymakers got fresh confirmation that inflation is continuing to ease, opening the way for a first interest rate reduction month as they focus on preventing further cooling in the labour market.

Money markets have been fully pricing a rate cut in September for weeks, but investors remain uncertain about the speed of the easing cycle in the medium term.

"Markets were largely muted in response to the euro area inflation figures (released on Friday) and the stronger-than-expected services inflation print" said Andrzej Szczepaniak, European economist at Nomura.

"This is likely partly because the boost from the Olympics (affecting services inflation) is expected to be temporary, and partly because the has shifted to adverse economic growth concerns," he added, arguing that recent data suggested Germany was "likely to tip into recession."

Germany's 10-year yield DE10YT=RR, the euro area's benchmark, was down 0.5 basis point at 2.28%, while the 2-year yield DE2YT=RR rose 2 bps to 2.39%.

"Today's data is fully consistent with the for another rate cut in September," said Chris Scicluna, head of economic research at Daiwa Capital Markets.

"But we are maintaining a view for just two more rate cuts this year, and that's because the Governing Council still has a relatively hawkish bias. It is still concerned about services inflation being too high," he added.

Traders were pricing in a 98% chance that the ECB will cut rates by 25 bps in September, while the odds of another such move in October stood at 58%. Traders overall saw rate cuts of 64 bps from the ECB by the end of the year.

"Data surprises in the euro area continue to be , as they do in the U.S.; a continuation of this could very well provide support for a further pricing of cuts," Nomura's Szczepaniak argued.

The moves in European bond markets this month have largely been dictated by shifting U.S. rate expectations, particularly after much weaker-than-expected payrolls data early in August fuelled bets of bigger rate cuts by the Fed.

Italy's 10-year yield IT10YT=RR was higher by 1 bp to 3.68%, and the yield gap between Italian and German bunds DE10IT10=RR was at 139 bps.

Investors will also be watching Sunday's election in two states in eastern Germany - Thuringia and Saxony - where anti-establishment parties are performing strongly in opinion polls.

(Reporting by Stefano Rebaudo and Sruthi Shankar; editing by Helen Popper, Toby Chopra and Jonathan Oatis)

((stefano.rebaudo@tr.com))