UPDATE 2-Germany's two-year bond yield hits six-week low on Fed inflation caution


* Euro zone bond yield fall as much as 5 bps

Sentiment lifted by dovish Fed statement

* German two-year bond yields dip to six-week lows

* Periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates prices)

By Dhara Ranasinghe

LONDON, July 27 (Reuters) - German short-dated government bond yields hit a six-week low on Thursday as investors detected a softening in the Federal Reserve's inflation view that could keep interest rates lower for longer.

The U.S. central bank left rates unchanged on Wednesday and said it expected to start winding down its massive holdings of bonds "relatively soon".

It noted that both overall inflation and a measure of underlying price gains had declined - trends which have worried some policymakers - but said it expected the economy to continue strengthening.

Investors seized on the comments as a sign that the Fed is unlikely to raise rates again soon, snapping up bonds and stocks and pushing the dollar down.

A Reuters poll showed most primary dealers still expect a rate rise in December. But rate futures price in less than a 50 percent chance of an increase by then, compared with a little more than 50 percent before the Fed meeting.

"There were few material changes to the FOMC statement published last night, but these changes reinforced the impression that the Fed is increasingly concerned about weakening inflation dynamics," Mizuho rates strategist Antoine Bouvet said.

Across the euro zone, 10-year government bond yields fell as much as 5 basis points on the day.

In Germany, the bloc's benchmark bond issuer, two-year bond yields dipped to a six-week low around minus 0.645 percent .

"Markets have become more relaxed about the chances of a year-end rate hike from the Fed, so that should give all bonds, especially short-dated, safe-haven ones support," said Rainer Guntermann, a strategist at Commerzbank.

He added that short-dated bond yields in Germany continued to face downward pressure from heavy buying for European Central Bank monetary stimulus. Because of a shortage of eligible debt for the scheme, bond buying in Germany this year has been focused on shorter-dated maturities.

A perception that the ECB is unlikely to rush into unwinding its massive stimulus given subdued inflation has also brought some relief to bond markets, rattled in the past month by the prospect of a "tapering" of the scheme.

The ECB might reduce asset purchases from the start of 2018 but should not completely end them, Austrian central bank governor Ewald Nowotny said late on Wednesday, adding that policymakers need a flexible, careful plan.

Inflation data from Spain and Germany on Friday could provide the next cues for bond markets.

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

(Reporting by Dhara Ranasinghe; editing by Larry King)