* Euro zone inflation unexpectedly slips in April
* German, French 10-year yields at 2-week lows
* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Writes through)
By Fanny Potkin and Dhara Ranasinghe
LONDON, May 3 (Reuters) - Euro zone government bond yields hit two-week lows on Thursday after April inflation in the single currency bloc unexpectedly slowed, a headache for the European Central Bank as it looks to unwind its monetary stimulus later this year.
Inflation fell to 1.2 percent in April, according to the Eurostat flash estimate. Economists polled by Reuters had expected it to be unchanged from 1.3 percent in March.
Inflation excluding volatile food and energy prices, the ECB’s preferred measure, slowed to 1.1 percent from 1.3 percent. The rate excluding energy, food, alcohol and tobacco, an even more narrow measure often tracked by market analysts, eased to 0.7 percent from 1 percent.
The data comes on the back of a softening in economic numbers and further tests the ECB’s resolve to roll back its hefty stimulus scheme.
“It’s certainly going to make for an interesting discussion at the ECB governing council,” Michael Hewson, chief market analyst at CMC Markets, said in the Reuters Global Markets Forum. “Rate rise expectations will be pushed back and 2019 is now very unlikely.”
The euro fell back from $1.1986 to $1.1972 after the data was released, though it was still up 0.2 percent on the day.
French and German 10-year government bond yields fell to 2-week lows after the data.
Germany’s Bund yield fell to 0.55 percent, below six-week highs hit last week above 0.65 percent, with the gap over 10-year U.S. Treasury yields at 239 bps and close to the widest in almost three decades.
“The data confirms this message that as much as in the U.S., the Fed is declaring victory and achieving its inflation target, the ECB remains way off and this is going to force the ECB in the end to go for a very gradual exit,” said Commerzbank rates strategist Michael Leister.
Southern European debt markets - seen as beneficiaries of ECB largesse - outperformed, dropping 2-3 basis points on the inflation data.
Later on Thursday, Italy’s outgoing centre-left Democratic Party (PD) is set decide whether to open government negotiations with the anti-establishment 5-Star movement in a bid to resolve an impasse following an inconclusive March 4 election.
On Wednesday, German central bank chief Jens Weidmann had said that expectations the ECB will lift interest rates towards the middle of next year remain realistic, because worries about an end of the euro zone’s economic expansion are overblown.
But after Thursday’s data, a market gauge of long-term inflation expectations in the euro zone dipped below 1.7, moving further away from a recent 8-week peak.
Money market pricing also suggests investors have tamed bets on rate hike around the middle of next year.
Eonia forward rates dated to the ECB’s meeting in June 2019 suggest an almost 80 percent chance of a 10 basis point rate rise is priced in. Just over a week ago, more than a 90 percent chance of such a move was anticipated.
Elsewhere, Spain and France auctioned 8.49 billion euros of long-dated bonds. (Reporting by Fanny Potkin and Dhara Ranasinghe; Additional reporting by Tommy Wilkes Editing by Raissa Kasolowsky)
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