Euro zone government bond yields edge up before economic data

By Stefano Rebaudo

Sept 20 (Reuters) - Euro zone government bond yields edged up on Friday as investors shifted their focus to economic data next week after pricing the outcome of the Federal Reserve policy meeting.

Risky assets rallied after the Fed as investors expected rates to fall further and the U.S. central bank to be close to winning its battle against inflation while engineering a soft landing for the U.S. economy.

Yields move inversely with prices.

German 10-year yields were up 0.5 basis points (bps) at 2.20%, and it was about to end the week 4.5 bps higher.

"After days of agonising over whether the Fed will deliver either a 25 bps or a 50 bps cut, the market can finally move back to looking at macro fundamentals and incorporating the different levels of exuberance central banks are showing towards policy easing," said Rohan Khanna, head of the euro rate strategy at Barclays.

September flash PMIs on Monday will be a crucial reality check on the region's growth momentum, which has recently disappointed expectations.

The Olympics-driven boost to French PMIs in August lifted the overall headline PMI, and markets expect some give-back.

Later next week, flash inflation releases for France and Spain are due before the German and euro area print the following week.

"We doubt the Fed will make ECB, Norges Bank or the Bank of England move faster," said Ruben Segura Cauyela, European economist at BofA.

Money markets fully price a 25 bps rate cut by the European Central Bank in December and an around 25% chance of a further move by year-end.

France's government bonds recently underperformed their peers, with its yields dropping 0.5 bps to 2.91% on Friday after rising 9 bps this week.

The yield spread between French and German Bunds - a gauge of risk premium investors demand to hold French government debt - widened to 73.5 bps. It hit 74.80 bps on Thursday, its highest level since mid-August. It rose above 80 bps during the French elections.

France appeared on the cusp of a new government on Thursday that is likely to have to administer a politically toxic round of spending cuts or tax hikes to improve the country's fiscal mess.

The five-year forward inflation swap- a key market gauge of euro area long-term inflation expectations- was at 2.06% after hovering above the 2% level since early September. It hit a 26-month low at around 2.03% on Sept. 11.

Germany's 2-year Schatz yields were up 2.4 bps at 2.159.

Italian 10-year yields fell 1.5 bps to 3.54 and are about to end the week 4 bps higher. The yield spread with Bunds was at 135 bps. (Reporting by Stefano Rebaudo, editing by Angus MacSwan)