×

UPDATE 1-Euro zone yields near one-week highs ahead of Fed meeting

* Fed likely to keep rates steady, signal balance sheet reduction

* Euro zone bond yields dip, stay near one-week highs

* Greece comeback bond improves sentiment towards bloc

* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Adds quote, updates prices)

LONDON, July 26 (Reuters) - Euro zone government bond yields edged lower but were still near one-week highs on Wednesday ahead of the U.S. Federal Reserve meeting, with rate setters expected to hint about tighter monetary policy in the future.

The Fed is expected to keep interest rates unchanged but possibly hint that it will start winding down its massive holdings of bonds as soon as September in what would be a vote of confidence in the U.S. economy.

Such a move would add to a sense across most developed countries that extraordinary monetary stimulus is drawing to close as economies slowly recover from a debilitating set of financial and debt crises between 2008 and 2012.

"The Fed has been rather clear up to now, and I expect it to signal today that balance sheet reduction will kick off in September and a rate hike will come maybe at the end of the year," said DZ Bank strategist Christian Lenk.

The yield on 10-year U.S. Treasuries stayed above 2.30 percent on Wednesday, having risen sharply by 8 basis points the day before, dragging European bond yields higher along with it.

Analysts at Citi said the two key points to watch for in the Fed meeting were the timing of balance sheet reduction and language discussing the recent slowdown in inflation.

"We would take as dovish any wavering in confidence that inflation will stabilize around 2 percent," the analysts said in a note.

Euro zone bond yields were 1-2 basis points lower across the board, but only after having risen sharply on Tuesday. Germany's 10-year government bond yield, for example, edged 1.5 basis points lower, having risen 7 basis points the day before.

At 0.55 percent, Germany's 10-year borrowing costs are still double what they were at this stage one month ago, as investors start to price in the European Central Bank's eventual tapering of its bond-buying program.

Greece's successful return to bond markets on Tuesday may improve sentiment a touch towards the euro zone as well.

"The Greek five-year bond may have added to the improvement of sentiment around the euro zone," said Rabobank strategist Matt Cairns. "And even though Greece is not out of the woods, the fact that here was 6.5 billion euros in orders for the deal is a fairly strong commitment from the market," he said.

The debt-laden nation successfully sold debt to private investors for the first time in three years on Tuesday, making a significant first step towards financial independence when its third international bailout ends next year.

Southern European government bonds tend to be sensitive to any concerns around Greece.

Italian and Portuguese government bond yields kept pace with better-rated counterparts, dropping a basis point each, while Spanish 10-year government bond yields were flat on the day at 1.54 percent.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.bi z / c m s / ? p a g e I d = l i v e m a r k e t s

(Reporting by Abhinav Ramnarayan Editing by Jeremy Gaunt.)