UPDATE 2-Euro zone bonds give up some gains as oil tumbles but expected Fed cut underpins

By Yoruk Bahceli
Updated

* Core government bond yields edge down

* Moves modest ahead of Fed rate decision Wednesday

* Netherlands expected to loosen up budget (Updates prices)

By Yoruk Bahceli

LONDON, Sept 17 (Reuters) - Euro zone government bonds gave up some early gains on Tuesday as oil prices slipped off 3-1/2-month highs, although the weekend attacks on Saudi oil facilities underpinned a cautious mood in world markets ahead of this week's expected U.S. rate cut.

Saturday's attack, which shut about 5% of global crude output, caused the biggest surge in oil prices since 1991 on Monday, sending investors flocking to safe haven assets.

Topped by uncertainty around Brexit, this halted a sell-off in euro zone government bonds after yields reached six-week highs last week. However, prices fell 6% after a Saudi Arabian source told Reuters production could be back on line within weeks. That helped global stock markets to recover and pressured bond markets.

Longer-dated euro zone government bond yields were seesawing around flat, inching off earlier session lows .

Germany's 30-year yield was down 1 bps to 0.05%. Its 10-year benchmark yield also marginally firmer at -0.47%.

"We've seen some flight to quality going into Bunds but taking into account what happened last week those moves remain rather limited - I think that's because we have the Fed [coming up]," said KBC rates strategist Mathias van der Jeugt.

The Federal Reserve is expected to cut rates by 25 basis points when it concludes its two-day meeting on Wednesday. Investors will also look to see if the Fed addresses the sudden surge in the overnight repurchase rate to 10% on Tuesday, well above the Fed’s target range of 2.00%-2.25%.

The rate eased back to 0% after the New York Fed said it would conduct a reverse repurchase operation

In the euro zone, focus this week is on the potential for government fiscal stimulus, with the Netherlands looking set to loosen its 2020 budget later on Tuesday.

The decision to relax fiscal discipline would come just a week after European Central Bank President Mario Draghi urged governments to spend more to avoid a downturn in the euro zone.

Earlier this week, plans for a Dutch investment fund of up to 50 billion euros were leaked in newspapers.

"If we see that [the leaked plans] reflected in the budget we could have more Triple A debt sales... we could have some kind of sell-off on core debt," said Natixis fixed income strategist Jean-Christophe Machado.

Italy's bond markets underperformed, with the 10-year benchmark yield up 8 basis points to 0.93%.

Former Prime Minister Matteo Renzi, who was instrumental in negotiating Italy's new coalition government, said he would break away form the ruling Democratic Party (PD) as he sought to set up a new centrist force in the country.

"In coming months the resignation of Renzi might not be that impactful, with Gentiloni leading negotiations between Brussels and Italy," Natixis' Machado said.

Analysts say the appointment of former Premier Paolo Gentiloni as the EU economic affairs commissioner is likely to help smoothen ties.

The European parliament meanwhile backed Christine Lagarde as the next ECB chief on Tuesday. (Reporting by Yoruk Bahceli; Editing by Angus MacSwan and Alexander Smith)