UPDATE 1-Euro zone yields drop as German business morale falls

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

LONDON, Feb 22 (Reuters) - Euro zone government bond yields dropped on Thursday after a survey showed German business confidence fell in February, offsetting an earlier rise in yields after the minutes of the last Federal Reserve meeting revived fears of inflation.

German business confidence fell more than expected in February but remained high, a survey showed on Thursday, suggesting that Europe's biggest economy is set for solid growth in the first quarter of this year.

Euro zone government bond yields, having been higher in early trade, fell 1 to 2 basis points across the board after the release. U.S. Treasury yields, which had hit multi-year highs overnight, also dropped to 2.92 percent, 4 bps off Wednesday's peak.

"The euro area economy has been picking up for awhile now and it's got to a point where expectations are for solid growth; but perhaps there aren't as many surprises in the data anymore," said Investec economist Victoria Clarke.

"Still, the big question mark is what the Fed and the ECB will do. The ECB minutes will be watched to see if there's any signal on when they move away from the minus 40-basis-point deposit rate," she said.

Minutes of the European Central Bank's last meeting are due later on Thursday.

German 10-year bond yields, the benchmark for the region, initially rose as much as 0.75 percent before dropping to 0.71 percent. Most other high-grade bond yields were 1 to 2 bps lower as well.

The "transatlantic spread" between German and U.S. 10-year borrowing costs widened to near a yearly high at 220 bps on Thursday, reflecting the diverging monetary policy expectations between the two countries.,


Greek government bonds were in demand, with yields dropping following after Moody's moved overnight to upgrade Greece two notches from "Caa2" to "B3" and maintained its positive outlook. The agency said it believed Greece will return to self-sufficiency and market-based funding.

Greece has also been upgraded by S&P Global and Fitch recently, but Moody's was not due to review Greece's rating until later.

"It came as a surprise in terms of the timing - but the overall rating story and economic story on Greece is on track," said DZ Bank analyst Sebastian Fellechner.

The yield on Greece's 10-year government bond was 9 basis points lower at 4.34 percent. Shorter-dated Greek 5-year government bond yields dropped as much as 19 basis points to 3.48 percent . (Reporting by Abhinav Ramnarayan, editing by Larry King)