UPDATE 1-Euro zone government yields extend decline as traders await US jobs report

Olga Cotaga


* Euro zone periphery govt bond yields http://tmsnrt.rs/2ii2Bqr (Updates prices, adds context on Fed, analyst comments, chart)

LONDON, Oct 4 (Reuters) - Euro zone government bond yields were set to fall for a third week on Friday as traders fretted about the impact U.S. tariffs might have on European economies, prompting them to buy safe-haven government bonds.

Bonds started to rally on Thursday, sending yields lower, after the United States said it would impose 10% tariffs on European-made Airbus planes and 25% duties on European products such as French wine, as punishment for illegal EU aircraft subsidies.

This has prompted the European Union to consider taking retaliatory measures in response to U.S. tariffs, said German Foreign Minister Heiko Maas on Friday.

A euro zone bond rally had stalled earlier in the week-- while U.S. Treasury yields tumbled -- as concern grew that the European Central Bank had only limited room to boost growth and inflation. But dismal economic data in the United States revived fears of recession and pushed euro zone yields back down.

Revised data on Friday showing the Italian economy grew slightly more than previously reported in the first half of this year aided sentiment towards the euro zone.

10-year bond yields across the bloc continued to fall by 1 to 3 basis points . Benchmark German 10-year Bund yields were down nearly 1 bps at -0.59% .

Traders will be watching whether euro zone yields fall further on Friday if the U.S. non-farm payrolls report comes in weaker than expected and raises expectations the Federal Reserve will cut interest rates by 25 basis point at the end of October.

Money markets are currently pricing in an 84% chance of such a cut this month.

"A weak (U.S. payrolls) number would be seen as putting some pressure on the Fed to consider further rate cuts this autumn," said Andy Cossor, rates strategist at DZ bank.

That would push down euro zone yields, but the fall would only be temporary, Cossor said. The "euro zone will be thinking about its own economic problems," referring to the impact of U.S. tariffs.

Meanwhile, a Reuters poll pointed to strong payrolls data, forecasting that 145,000 jobs were added in September, an increase on the August reading.

However, "a firmer print will not change the markets' view that the U.S. and global economies are in decline," said Rabobank analysts in a client note. Rabobank expects a third Fed rate cut this year, after 25 bps cuts in July and September

Rabobank's view remains that the inverted yield curve points to a recession next year, which "will force the Fed to cut rates all the way to zero before the end of 2020," analysts said.

Elsewhere, Italy was ready to issue its first new dollar bond in nearly a decade, sources told Reuters on Thursday. The sale may be announced as early as next week.

DBRS is expected to review its positive-outlook rating for Portugal on Friday night, two days ahead of a parliamentary election in which Prime Minister Antonio Costa is expected to win a second term.

(Reporting by Olga Cotaga; Editing by Catherine Evans)