October 24, 2018 / 9:22 AM / 23 days ago

UPDATE 3-Euro, German bond yields drop as surveys signal slowing growth

* German yields hit day's low after euro zone PMI data

* Euro down half a percent on day

* Italian yields rise up to 7 bps

* Euro zone periphery gov't bond yields tmsnrt.rs/2ii2Bqr (Updates prices)

By Abhinav Ramnarayan and Virginia Furness

LONDON, Oct 24 (Reuters) - The euro fell and the euro zone's government bond yields dropped on Wednesday after data showed business growth in the single currency area lost more momentum than expected, as trade tensions and worries over Italy overshadow the economy.

The bid for quality assets gathered pace after the U.S. market open, with most of the single currency area's bond yields falling further as equity markets were pushed lower by bearish sentiment over trade conflicts, concerns about Italy's budget and criticism of Saudi Arabia over the killing of a journalist.

Euro zone business growth decelerated faster than expected as the final quarter of 2018 began, dragged down by waning orders that dented confidence, according to a purchasing managers survey released on Wednesday.

"The flash PMI for October gives a first glimpse on where the euro zone economy is heading. And the picture is not terrific," ING economist Peter Vanden Houte said in a note.

The data for the single currency area came after French and German business surveys released earlier also undershot expectations. .

Germany's 10-year bond yields fell three bps to a low of 0.39 percent. Other high-grade euro zone bond yields also fell with France's 10-year yield hit a five-week low of 0.76 percent while Spain's 10-year bond yield fell four basis points to a two-week low of 1.62 percent.

The European Central Bank is due to meet on Thursday, when its president, Mario Draghi, may hint at how concern over Italy's budget and equity market downturns will affect monetary policy.

"Besides risk sentiment, economic sentiment should be key today as both can influence the tone at tomorrow's ECB meeting," Commerzbank analysts said in a note to clients.

DIFFICULT PERIOD

Italian government bond yields rose as much as seven basis points in late trade on Wednesday as a recovery in European stocks proved short lived, and Italian banking stocks fell.

Italy's sovereign yields rose across the curve, extending the weekly highs they reached on Tuesday after the European Union rejected the country's draft budget for 2019.

Its five-year government bond yields were seven bps higher on the day to 2.97 percent, while its 10-year bond yields rose four bps to 3.62 percent,.

One analyst said selling in Italian bonds was led by the Italian equity market, which was down around 1.69 percent . Others said comments by Italian Deputy Prime Minister Luigi Di Maio on the so-called "golden power" rules did not help.

The rules allow the government to veto strategic decisions such as asset sales and mergers at businesses deemed to be of strategic national importance.

"The government is doing things that aren't that business friendly," said Lyn Graham Taylor, rates strategist at Rabobank.

Investors are also cautious on Italian bonds ahead of a ratings review by S&P Global on Friday. S&P is due to review Italy's credit rating, currently at BBB with a stable outlook.

Analysts expect a downgrade, but are divided on whether this will only be lowering the outlook to "negative", or whether Italy's credit rating will be cut to BBB-, the lowest investment-grade rating. (Additional reporting by Tommy Wilkes, Danilo Masoni in Milan Editing by David Holmes and Helen Popper)

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