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UPDATE 2-Euro zone bond yields near one-week highs before Fed decision

* 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 (Updates prices)

LONDON, July 26 (Reuters) - Euro zone government bond yields edged down but stayed near one-week highs on Wednesday ahead of a policy decision by the U.S. Federal Reserve, with rate setters expected to hint at future monetary tightening.

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 debilitating 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.

Analysts at Citi said the two key points to watch for from the Fed 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," they said in a note.

Euro zone bond yields dipped 1-2 basis points on the day having risen sharply on Tuesday alongside their U.S. equivalents. The latter also steadied, with 10-year Treasury yields flat at around 2.33 percent.

Germany's 10-year government bond yield was 1.5 bps lower, after rising 7 bps 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 helped lift sentiment towards euro zone bonds in general.

"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.

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

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 and John Stonestreet)