Euro zone yields pinned lower as ECB's Draghi talks down inflation

By Dhara Ranasinghe and Abhinav Ramnarayan

LONDON (Reuters) - Euro zone government bond yields drifted lower on Monday with Germany's benchmark Bund yield briefly touching a one-month low, as investors positioned for a run of potentially market-moving data and events this week.

Having already dipped in early trade, bond yields were pinned lower as ECB chief Mario Draghi told the European Union parliament that slack in the euro zone economy might be bigger than estimated, slowing the rise of inflation.

Lower inflation would cool expectations of an aggressive reduction of extraordinary stimulus by the ECB and provide support for a bond market that has sold off steadily in recent weeks.

"If a similar message to this gets communicated at the rates meeting, it could take the wind out of the sails of those expecting a repricing of the rates curve," said Mizuho strategist Peter Chatwell.

He added, though, that in order to do so Draghi would have to win over the more hawkish policymakers at the central bank.

Germany's 10-year government bond yields were unchanged at 0.65 percent towards the close of the trading session, having hit a one-month low of 0.64 percent in early trade.

It is 15 bps below a more than two-year high hit earlier this month.

Peripheral bond yields, which came under some selling pressure last week from pre-election jitters in Italy, were down 3-4 basis points on the day.

This debt is generally seen as the biggest beneficiary of ECB largesse, and therefore most sensitive to any talk of monetary policy tightening.

Later this week, new Federal Reserve head Jerome Powell delivers his semi-annual testimony to Congress starting on Tuesday, and a flash estimate of euro zone inflation data for February is due on Wednesday.

On Sunday, Italians vote in a national election expected to result in a hung parliament, the same day results are due from a ballot of Social Democratic party members on a coalition deal that could seal or end German Chancellor Angela Merkel's hopes of a fourth term in office.

For now, investors are just biding their time with bond yields extending recent falls, analysts said. "The euro zone growth story outweighs the political story in Italy at the moment," said Rabobank fixed income strategist Matt Cairns.

Government bond markets across the world have recovered some ground in the past week after a recent sharp sell-off on jitters that strong economic growth and signs of a pick-up in inflation will encourage central banks to press ahead with reversing ultra-loose monetary policies.

German 10-year bond yields are set to end February down around 4 basis points, their biggest monthly fall since October.

On Friday, ECB executive board member Benoit Coeure said the bank had bought enough bonds for it to retreat from further purchases without risking an unwarranted rise in longer-dated bond yields.

(Reporting by Dhara Ranasinghe; Editing by Mark Heinrich)