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* Euro zone bond yields rise
* PMI data eases recession fears
Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates with ECB minutes, updates prices)
By Virginia Furness
LONDON, Aug 22 (Reuters) - Most euro zone bond yields rose on Thursday after data showed service sector activity picked up in August and manufacturing contracted less than expected.
Italian government bond yields fell on expectations a new government will be formed soon, as markets digested news that Federal Reserve policy makers were divided over the path of interest rates.
The euro zone's service industry expanded but factory activity contracted for the seventh month in a row, although at a slower rate than the previous month, according to IHS Markit's flash purchasing managers' indexes.
The composite PMI, which combines services and manufacturing and is considered a good guide to economic health, rose in August to 51.8 from 51.5 in July, above the 51.2 predicted in a Reuters poll. Anything above 50 indicates growth.
Across the euro zone, 10-year bond yields were 3-4 basis points higher on the day, while a key gauge of the market's long-term inflation expectations rose to a three-week high at 1.28%.
Germany's 10-year bond yields were up 3 bps at -0.64% and 30-year yield rose 4 bps to -0.14%. Thirty-year debt sold for a record-low yield of -0.11% at an auction on Wednesday but raised only 824 million euros versus a target of 2 billion euros.
A day after minutes of the Federal Reserve's last meeting showed the Fed was divided over how to respond to slowing growth in the United States, minutes from the European Central Bank's last meeting flagged stimulus is on its way.
A combination of measures may be needed to prop up the euro zone economy, as recent indicators paint an even bleaker picture of the outlook, ECB policymakers said at their July meeting.
"For the ECB it is the design of the overall package; there are so many options. For the Fed there is only how much to cut and when to cut," said Michael Leister, rates strategist at Commerzbank.
Data showed U.S. manufacturing industries recorded their first month of contraction in almost a decade in August, sparked a fresh inversion of the U.S. 2-10 bond yield curve .
Global central bankers meet at Jackson Hole, Wyoming, for their annual gathering on Friday, and markets will be looking for any signals from there.
Italian government bond yields briefly fell after Reuters reported President Sergio Mattarella wanted clear signs of a possible deal to form a new government by the end of the day.
In late trade, most Italian yields slightly lower on the day, with the 10-year Italian/German bond yields gap below 200 bps and close to its tightest in almost a month.
(Reporting by Virginia Furness; Editing by Alison Williams)