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UPDATE 1-As trade, growth worries mount, investors flock to European safe-haven debt

Dhara Ranasinghe and Tommy Wilkes

safe-haven debt@

* Euro zone core bond yields near 2016 lows

* Italy yields fall from recent highs but nerves remain

* EZ inflation expectations gauge at lowest since 2016

* Best on ECB rate cut by year-end rise

* Euro zone periphery bond yields (Adds fresh quote, context, updates prices)

LONDON, May 16 (Reuters) - Jittery investors piled into European safe-haven government bonds again on Thursday, rattled by U.S.-China trade tensions, concerns about a slowdown in global growth and fears that Italy may break European Union fiscal rules.

The nervousness in bond markets contrasted with a more forgiving tone in equity markets in recent days, and analysts said bond investors remained on edge about the cocktail of risks building.

Germany's benchmark 10-year bond yield dropped 2 basis points and was close to 2-1/2 year lows touched on Wednesday at minus 0.13%.

Dutch 10-year bond yields fell towards 0%, which would mark its lowest since late 2016, and French 10-year bond yields fell to just 0.278%, its lowest since 2016.

Overnight news that the United States has hit Chinese telecoms giant Huawei with severe sanctions added another incendiary element to the U.S.-China trade dispute and kept investors cautious.

A surprise drop in United States retail sales in April on Wednesday followed weaker Chinese economic data and renewed worries about the health of the global economy, sending investors into U.S government bonds.

"There's a lot more risk and uncertainty in global growth mainly through trade concerns," said Rabbani Wahhab, senior fixed income portfolio manager at London and Capital.

"We're concerned that the volume of trade, which is very important to the euro zone, is going to hurt more as we go through 2019 and that's showing up in the demand for high-grade euro zone bonds."

Yields on 10-year U.S. Treasury bonds neared a 15-month low and Fed funds rate futures are now fully pricing in a rate cut by the end of this year.

Investors also raised bets on a rate cut from the European Central Bank, with Eonia money market futures pricing in roughly a 30% chance of a 10 basis point rate cut by the end of the year..

In another concerning sign for the ECB, a key market gauge of long-term euro zone inflation expectations fell to 1.3240%. That was its lowest level since 2016 -- a year the ECB ramped up asset purchases and cut rates to a record low to fight deflation.


In contrast, Italy's borrowing costs initially edged higher on worries about the country is headed for another showdown with Brussels over its budget expansion plans.

The two-year yield later fell, dropping four basis points to 0.70%. The 10-year stood at 2.70% - holding below Wednesday's peak of around 2.81%, its highest level since February - as one of the two ruling parties pushed back against the idea it would grow public debt in the third-largest and heavily indebted euro zone member.

The ruling 5-Star Movement will oppose a budget law that boosts public debt though the government is committed to avoiding an increase in the sales tax that would support state revenues, deputy Prime Minister Luigi Di Maio was quoted as saying on Thursday.

"Risk sentiment showed some signs of rebounding late yesterday but I would still err on the side of caution," said KBC rates strategist Mathias van der Jeugt.

(Editing by Andrew Cawthorne/Keith Weir)