Euro zone bond yields fall as PMIs indicate sluggish growth

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Euro zone composite PMI stays in contraction

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ECB policymakers differ on December rate cut size

(Updates prices at 1524 GMT)

By Samuel Indyk

LONDON, Oct 24 (Reuters) - Euro zone government bond yields fell for a second day on Thursday after business activity data confirmed growth is set to remain sluggish in the fourth quarter, supporting the case for further European Central Bank rate cuts.

HCOB's preliminary composite purchasing managers' index rose to 49.7 in October from 49.6 in September, but remained below the 50 threshold that separates growth from contraction for a second straight month.

A Reuters poll of economists forecast a rise to 49.8.

"The PMI figures have contributed to the view that price pressures are easing and the labour market is weakening," said Jussi Hiljanen, head of European rates strategy at lender SEB.

"The market is continuing to pivot towards a 50 basis point move (from the ECB) in December."

Traders are fully pricing a 25 basis point rate cut at the central bank's next policy meeting in December, and around a 43% chance of a larger 50 bp move.

ECB officials, while signalling support for lower borrowing costs, have differed on their views on the pace of rate cuts and the endpoint for interest rates.

Portuguese rate-setter Mario Centeno said rates could be cut by 50 bps at the central bank's December meeting. Hawkish policy maker Robert Holzmann said another 25 bps reduction was not ruled out but also not decided yet.

ECB President Christine Lagarde, speaking on Wednesday, sounded more cautious when deciding on further interest rate reductions, saying the central bank must take its cue from incoming data.

Germany's 10-year yield, the benchmark for the euro zone, was down 7 bps at 2.242%. It rose to 2.334% on Tuesday, its highest since Sept. 3. Yields move inversely with prices.

The two-year yield, which is more sensitive to changes in interest rate expectations, fell 5 bps to 2.086%.

Money markets currently see the ECB deposit rate bottoming out at about 1.8% in the second half of next year, as growth remains sluggish.

Italian policymaker Fabio Panetta said on Wednesday that the ECB may need to cut interest rates beyond the neutral rate to a level low enough to stimulate the economy.

Italy's 10-year yield, the benchmark for the more indebted countries in the euro zone's periphery, fell 6.8 bps to 3.46%, keeping the spread between Italy and Germany's 10-year yields steady at about 120 bps.

Britain's bonds underperformed their European counterparts, as finance minister Rachel Reeves unveiled a change to the country's fiscal rules to unlock additional funds for investment spending in next week's budget.

Britain's 10-year gilt yield rose 2.6 bps at 4.227%, with the gap between German and UK 10-year yields widening as far as 198 bps, before retreating to around 189 bps. (Reporting by Samuel Indyk; Editing by Toby Chopra, Sharon Singleton and Alison Williams)