Euro zone bond yields rise on trade deal expectations, ECB pause

*

EU diplomats suggest nearing deal for 15% US tariffs

*

ECB holds interest rates steady as forecast

*

Euro zone business activity accelerates, survey says

(Updates after ECB decision)

By Samuel Indyk and Lucy Raitano

LONDON, July 24 (Reuters) - Euro zone bond yields rose Thursday as risk sentiment improved on expectations the European Union will strike a trade deal with the United States, while the European Central Bank, as forecast, held its interest rates steady.

Two EU diplomats said late on Wednesday that the 27-member bloc was heading towards an agreement that would result in broad 15% tariffs on its exports to the U.S., avoiding a harsher levy of 30% scheduled to be implemented from August 1.

The U.S. later called the talk of a trade deal with Europe "speculation", but markets still believed a deal was on the horizon before next week's deadline.

"Bunds dropped like a hot potato ... with risk sentiment turning for the better on 15% tariff headlines for EU goods," Commerzbank rates strategist Hauke Siemssen said in a note.

Germany's 10-year yield, the benchmark for the euro zone, rose 8.5 basis points (bps) to 2.686%, on track for its biggest one-day rise since May 12. Bond yields move inversely with prices.

Germany's two-year yield, more sensitive to changes in interest rate expectations, rose 6.5 bps to 1.859%.

The ECB kept all three interest rates unchanged, in line with expectations, taking a break from policy easing to await clarity regarding Europe's trade relations with the United States.

"The ECB right now isn't really moving the needle," said Evelyne Gomez-Liechti, multi-asset strategist at Mizuho, adding that markets were focused on the EU-U.S. trade discussions.

Markets had earlier trimmed expectations for future reductions in borrowing costs after the reports of a possible EU-U.S. trade agreement.

"At the margin, it (a possible trade deal) reduces the odds for rate cuts," said Jussi Hiljanen, chief rates strategist at SEB.

Futures now imply about a 40% chance that the ECB will lower borrowing costs in September from a near 50% chance on Wednesday. Markets are pricing just 22 bps of easing by the year's end, implying about a 90% chance of a quarter-point move.

Business activity in the euro zone accelerated faster than expected this month, supported by a solid improvement in the services industry and signs of a recovery in the manufacturing sector, a survey showed on Thursday.

HCOB's preliminary composite euro zone Purchasing Managers' Index, compiled by S&P Global, rose to an 11-month high of 51.0, above expectations for 50.8 in a Reuters poll of economists.

Italy's 10-year bond yield, the benchmark for the euro zone periphery, rose 6.5 bps to 3.521%. (Reporting by Samuel Indyk; Editing by Barbara Lewis and Joe Bavier)