×

UPDATE 1-South European yields drop on stable euro zone inflation

* Euro zone inflation remains well below ECB target

* Unwinding of stimulus likely to be gradual, analysts say

* Italian, Portuguese and Spanish yields drop 2-3 bps

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

LONDON, July 31 (Reuters) - Southern European government bond yields slipped on Monday as euro zone inflation for July remained well short of the European Central Bank target, thereby weakening the case for a rapid unwinding of monetary stimulus.

On Friday, euro zone yields had shot up across the board, with Germany's 10-year borrowing costs hitting 19-month highs, after German inflation for July beat expectations, rising 1.5 percent rather than the 1.4 percent forecast by most.

But the move proved to be short-lived, as most analysts realised that this wasn't enough of a surprise to significantly impact the figure for the entire bloc.

A flash estimate of euro zone inflation showed that consumer price rises in July were level with the month before, standing stable at 1.30 percent and in line with forecasts of economists polled by Reuters.

The ECB targets inflation of "just below 2 percent".

Core inflation, at 1.3 percent, was at its highest in four years and unemployment was at its lowest since 2009, but this was still not enough to significantly move yields.

"It's a step in the right direction but not quite enough to make the market reconsider bond prices," said Mizuho strategist Antoine Bouvet.

"Tapering is already priced in, so while it's good news and progress, it's not something that would make the market reassess its view."

Italian, Spanish and Portuguese bonds, seen as the biggest beneficiaries of central bank stimulus, outperformed the rest of the market, dropping 2-3 basis points.

Higher-rated government bond yields were flat to a touch higher.

At one stage, the gap between Portuguese and German 10-year borrowing costs tightened to its narrowest level since January 2016, at 233 basis points.

Large redemptions of Italian bonds due this week may also be pushing southern European government bond yields lower, said Bouvet.

Current expectations are for the ECB to announce the tapering of its 2 trillion euro bond-buying scheme in the autumn, and then implement it in 2018.

Those expectations were built into bond prices over the last month. Germany's 10-year borrowing costs are more than double what they were in late June, when the bloc's top policymaker, Mario Draghi, said he was open to policy tweaks in a speech in Sintra, Portugal.

"I think the assessment of inflation will be in autumn when central banks come back from vacation," said DZ Bank strategist Sebastian Fellechner.

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 Maayan Lubell)