Aug 15 (Reuters) - Euro zone government bond yields fell on Monday with investors concerned about a possible recession after weak data from China and amid persistent fears of production cuts in Germany due to potential gas rationing.
China's central bank reduced key lending rates in a surprise move on Monday to revive demand. Data showed the economy slowed in July, with factory and retail activity squeezed by Beijing's zero-COVID policy and a property crisis.
"There are two clear-cut drivers behind today's fall in yields - weak China data and concerns about the impact of gas supply disruptions on the German economy," said Rohan Khanna, research strategist at UBS.
Germany must cut its gas use by a fifth to avoid a crippling shortage this winter, its top network regulator said, as businesses and households brace for Europe's biggest energy crisis in a generation, the Financial Times reported.
U.S. Treasuries provided further downside pressure to euro area borrowing costs, with the 10-year yield falling 5 basis points (bps) to 2.795%.
Germany's 10-year government bond yield, the benchmark of the bloc, fell as much as 11 basis points (bps) to 089%.Last Friday it hit its highest since July 25 at 1.025%.
Germany's 2-year yields, more sensitive to central bank rate hike expectations, fell 8 bps to 0.52%, after briefly hitting the highest since July 22 at 0.643%.
Money markets are pricing in a 50 bps hike from the European Central Bank (ECB) at its meeting in September, in addition to a slight chance of a more significant rate rise.
Investors are waiting for the Federal Open Market Committee (FOMC) minutes on Wednesday and the Jackson Hole symposium next week after Fed officials provided some hawkish comments despite U.S. producer prices falling in July.
"The consistently hawkish Fed communication is not yet fully discounted in our view with markets looking for only 50 bp in September," Commerzbank analysts said in a research note to clients about the ECB's likely next move.
Italy's 10-year yield fell 10 bps to 2.98%, with the spread between Italian and German 10-year yields at 207 bps. It widened to more than 260 bps immediately after the collapse of Mario Draghi's government last month.
Analysts highlighted two factors behind the recent spread tightening.
Firstly, the ECB's so-called first line of defence against excessive divergence among bond yields - Pandemic Emergency Purchase Programme (PEPP) reinvestments – provided significant support for the peripheral bond markets of Italy and Spain during July.
Additionally, Italian right-wing bloc leaders said they would stick to European Union budget rules, easing some fears the country could distance itself from the EU if the conservative alliance wins the Sept. 25 election.
"In the summer months, the impulse to sell BTPs is very limited after reassuring remarks from right-wing coalition leaders and the ECB reinvestments," Khanna of UBS said.
"But how long it will take to form a ruling coalition and what happens with the new government remain a big question mark. So we can see a new spread widening after the vote."
(Reporting by Stefano Rebaudo Editing by Mark Potter and David Evans)
