Euro zone bond yields slide as traders bet on October rate cut

(Updates at 1110 GMT)

By Harry Robertson

LONDON, Oct 1 (Reuters) - Euro zone bond yields dropped on Tuesday as data showed inflation in the bloc fell below the European Central Bank's 2% target in September, and comments from ECB officials bolstered bets on an October rate cut.

Data on Tuesday showed euro zone inflation fell to 1.8% year-on-year in September - below the 2% level for the first time since mid-2021 - from 2.2% in August.

Germany's 10-year bond yield, the benchmark for the euro zone bloc, fell 8 basis points (bps) to 2.052%, its lowest since January. Yields move inversely to prices.

"It's a big change that has been taking place over the past few days, over the past week, when it comes to interest rate expectations," said Jussi Hiljanen, head of European rates strategy at lender SEB.

"Basically an October rate cut has been baked into the pricing. That has been having an impact on yields."

Traders in money markets on Tuesday saw a roughly 85% chance of a 25 bp cut from the ECB in October, up from 75% on Monday and 45% a week ago. The ECB cut rates by 25 bps in June and again in September, taking them to 3.5%.

Italy's 10-year yield fell 9 bps to 3.376%, while the gap between Italian and German yields stood at 132 bps.

Investors were keeping an eye on a sharp drop in oil prices, which slid 2% on a stronger supply outlook and subdued demand despite Israel beginning a ground incursion into Lebanon.

Germany's two-year bond yield was down 3 bps at 2.04%, the lowest since December 2022.

Finnish ECB policymaker Olli Rehn said on Tuesday that the inflation slowdown means there are now more reasons to justify an interest rate cut at the October meeting.

President Christine Lagarde on Monday said the ECB will take into account the drop in inflation when it meets later this month.

France's 10-year bond yield fell 11 bps to 2.813%, helping the gap between French and German yields narrow to 76 bps.

Emmanouil Karimalis, macro rates strategist at UBS, said a media report that France's new government is considering tax hikes of 15 billion to 18 billion euros ($16.71-20.06 billion) was likely reassuring investors about French debt and helping other longer-dated bonds. (Reporting by Harry Robertson; Editing by Andrew Heavens and Christina Fincher)