Euro zone yields inch down as inflation data, Fed decision eyed

LONDON, Feb 1 (Reuters) - European government bond yields inched down from near the top of their recent ranges on Wednesday, the start of an agenda-setting few days for markets, with euro zone inflation data and the Federal Reserve's policy decision later in the day.

Germany's 10-year government bond yield was at 2.26%, down 1 basis point (bp) on the day, but still near Monday's two-week high of 2.325%, hit after higher-than-expected Spanish inflation raised fears that euro zone inflation may not be slowing as much as some investors had hoped.

Italy's 10-year yield fell 2 bps to 4.25%, but remained near Monday's two-week high.

"The start of February today marks a pivotal three days for markets that have the potential to decisively set the tone for the weeks ahead," said Deutsche Bank strategist Jim Reid in a morning note to clients.

European inflation data, due at 1000 GMT, is expected to show consumer prices rose at a rate of 9% in January. A reading above this could put pressure on the European Central Bank to keep raising interest rates aggressively.

The relentless pace of central bank rate increases prompted a significant sell-off in global government bonds in 2022 that pushed yields, which move inversely to prices, to their highest in years.

Investors widely expect the ECB to raise rates by 50 basis points on Thursday, but the outlook after that is less clear. Markets are pricing for rate cuts later this year, but ECB policymakers, including central bank President Christine Lagarde, have not signalled that a pause is coming any time soon.

"There is a chance that the market is right in running ahead of the ECB. But historically the ECB has stayed restrictive for longer," said Chris Attfield, European rates strategist at HSBC.

"The crucial thing that will alter market expectation is core inflation," Attfield said.

Core inflation is expected to have risen by 6.9% in the 12 months to January, matching December's pace.

The Fed concludes a two-day meeting on Wednesday, its first of the year. Money markets show traders expect the Fed to raise rates from their current 4.25-4.50% target range by just 25 bps.

Even though Chair Jerome Powell and his colleagues have repeatedly expressed their concern about the persistence of inflation, traders expect no more than a couple of small increases that will see rates peak around 4.9% by June.

In the euro zone, shorter-dated paper came under a little more pressure. Germany's two-year Schatz yield, which is more responsive to shifts in expectations for interest rates and inflation, was flat at 2.629%, while Italian two-year yields , which hit a four-week high on Tuesday, were up 1 bp at 3.25%. (Reporting by Alun John and Susan Mathew; Editing by Emelia Sithole-Matarise)