UPDATE 3-Euro zone bond yields fall as German inflation dips

(Updates prices)

By Harry Robertson

LONDON, Feb 9 (Reuters) - Euro zone government bond yields fell on Thursday after four days of increases as cooler German inflation data tempered investor expectations for euro zone interest rates to rise much further.

The yield on Germany's 10-year government bond, the benchmark for the euro zone, hit a session low of 2.256% before edging above that. It was last down 5 basis points at 2.31%.

Data on Thursday showed German consumer prices, harmonised to compare with other European Union countries, rose 9.2% on the year in January, compared with a rise of 9.6% in December and below expectations.

The narrative that the European Central Bank (ECB) might limit its rate increases is taking hold again, said Piet Haines Christiansen, fixed income strategist at Danske Bank.

Yields, which move inversely to prices, dropped after rising for four sessions, in spite of a warning from ECB officials that interest rates will have to climb considerably higher.

The German data gave bonds an excuse to rise following recent weakness, said Pooja Kumra, senior European and UK Rates strategist at TD Securities.

"Focus still remains on how sticky core inflation will be in coming weeks. Markets are underestimating how sticky inflation can be, especially given the fact that the ECB is not changing their rhetoric that much."

Euro zone core inflation, which strips out volatile energy, food, alcohol and tobacco prices, remained at a record high of 5.2% in January.

"What we have been seeing over the last two weeks is basically markets first overreacting post central bank meetings and now we are trying to undo some of those moves as well," Kumra said, adding that she expects range-bound trading till the March central bank meetings.

The ECB raised its benchmark rate by 50 bps to 2.5% last week, and signalled it was not finished. Yet some ECB officials have pushed back hard against the idea that they're nearly done.

ECB Vice-President Luis de Guindos said on Wednesday markets could be too optimistic about inflation.

Italy's 10-year yield, seen as a benchmark for so-called periphery countries, fell 10 bps to 4.138% on Thursday. That narrowed the closely watched gap between Germany and Italy's 10-year yields to 181.5 bps.

Euro zone yields have fallen sharply since hitting multi-year highs in 2022, with a drop in energy prices easing some of the pressure on the ECB to keep raising rates.

Germany's 10-year yield is now well below late December's 11-year high of 2.569%.

Germany's 2-year bond yield, which is highly sensitive to interest rate expectations, fell 2 bps to 2.688%. They had jumped in the previous session after the ECB said it would cut the interest rate it pays governments on deposits.

Italy's 2-year yield was down 6.2 bps at 3.20%.

The next big data point for global markets comes on Tuesday with the release of U.S. consumer price index inflation figures.

(Reporting by Harry Robertson, Amanda Cooper and Susan Mathew; Editing by Arun Koyyur, Mark Heinrich and Shounak Dasgupta)