ECB rate-cut bets drive another big weekly fall in bond yields

* ECB easing hopes bolster bond markets

* German Bund yield set for biggest fall in seven weeks

* Focus on ECB inflation target debate

* Markets ramp up bets on July ECB rate cut

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates prices, adds comment)

By Dhara Ranasinghe

LONDON, July 19 (Reuters) – Anticipation of ECB rate cuts put German yields on track for their biggest weekly drop in seven weeks on Friday, while Italian borrowing costs were set for a seventh week of declines despite rising off 3-year lows hit the previous day.

Euro zone debt has resumed its rally after last week’s brief selloff, receiving fresh impetus after a report that European Central Bank staff were studying a potential change of the inflation goal. That’s added to expectations for prolonged policy easing.

“Last week, we did see a big selloff and when we entered this week it was a buying opportunity because central banks are expected to ease policy,” said Pooja Kumra, European rates strategist at TD Securities in London. “And adding to that we’ve had further signals that we will get easing soon.”

Comments by two Federal Reserve officials have also revived bets on a 50 basis-point U.S. interest rate cut this month, though 10-year Treasury yields inched higher on Friday after falling on Thursday .

With the exception of Italy, most 10-year euro area bond yields slipped, though they inched off session lows as U.S. yields rose.

Germany’s 10-year yield fell 1.5 bps to minus 0.32% . It is down almost eight bps this week and set for its biggest weekly fall since the end of May.

In focus now is the ECB’s July 25 meeting that is expected to flag a cut in deposit rates as early as September. Money markets suggest some investors expect a move as early as next week, pricing almost a 60% chance of a 10 bps cut, up from around 40% earlier this week.

Natixis fixed income strategist Cyril Regnat said it would make more sense to wait until September but added: “The big question is not about a rate cut but whether the ECB reopens asset purchases.”

“This is what investors keep asking us about.”

Bets on a deeper and longer rate-cutting cycle and the possibility of another bond-buying programme sent a key gauge of long-term euro zone inflation expectations, the five-year, five-year forward, to the highest in almost two months at 1.32% .

ITALY

Italian 10-year borrowing costs were the exception to the bullish mood, though analysts noted a seven bps rise came after yields fell to a new three-year low of 1.506% on Thursday.

Yields have fallen around 120 bps since mid-May, having outperformed euro zone peers thanks to the ECB easing speculation and relief that Rome avoided disciplinary action from the European Union over its fiscal position.

This week yields are down more than 10 bps.

But on Friday investors grew nervous as Deputy Prime Minister Matteo Salvini said he would meet coalition partner Luigi Di Maio amid speculation that the increasingly unwieldy government might collapse.

While investors might welcome an administration that excludes Di Maio’s 5-Star movement, there needs to be a government in place in October to approve the 2020 budget.

Analysts at Eurasia Group said while pressure on Italian markets had lifted, they would remain volatile.

“The coalition remains inherently unstable and early elections remain likely, though probably not before early 2020,” they told clients.