UPDATE 2-Europe's bond yields limp lower as recovery splutters

* Bund yields sit back at 0.5% after weak PMI data

* Longest run of falls for Bunds since Jan

* Italian and Spanish yields shrug off rising virus numbers

* Inflation expectations dip again

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Updates at European markets close)

By Elizabeth Howcroft

LONDON, Aug 21 (Reuters) – Core European government bond yields fell further on Friday, with Germany’s 10-year Bund rate pushed back to -0.5% against the backdrop of rising COVID-19 infections and a faltering economic recovery.

Safe-haven government debt has rallied this week as central bank stimulus, doubts about the economic recovery in the United States, and global risk-aversion due to U.S.-China tensions pushed yields back towards their early-August lows.

Forward-looking euro zone purchasing manager data showed that economic recovery in the region slowed in August, particularly in services, as last month’s post-lockdown boost effect wore off.

Analysts at Barclays said the PMI fall had been much steeper than expected and showed the “treacherous path” the economy was still on.

“We expect the recovery to be bumpy, vulnerable, gradual and protracted, and so very much reliant on policy support,” they added.

A full bounceback from the euro zone’s deepest recession on record will take two years or more, according to a recent Reuters poll of economists.

France set a new post-lockdown record high for daily coronavirus infections on Thursday, and cases are also surging in Spain.

Most core yields were down one to two basis points going into the close with riskier Italian yields also ending down after reversing a modest nudge higher during the morning .

Germany’s 10-year Bund yield was at -0.50%, marking in its sixth consecutive day of falls and longest falling streak since January this year, when markets were first grappling with the coronavirus pandemic and focus was starting to turn to fresh European Central Bank action.

It came too as the pan-European STOXX 600 index provisionally closed down 0.2% on the day for a 0.9% weekly loss.

There was little reaction, meanwhile, to news that Britain and the European Union had made scant progress towards a post-Brexit trade deal in talks this week, with both sides again blamed the other.

“Those who were hoping for negotiations to move swiftly forward this week will have been disappointed,” the EU’s chief negotiator, Michel Barnier, told a news conference after two days of talks in Brussels.

Germany and France said on Thursday they would coordinate their coronavirus-related travel restrictions. German Chancellor Angela Merkel said she wanted to avoid closing borders again and that there is a desire in Europe for a common approach to the virus.

RBC rates strategists said that a tightening of lockdown restrictions and changes in consumer behaviour due to the resurgence in coronavirus cases across Europe would “almost certainly” have an economic impact in September.

Minutes from the ECB’s July meeting this week showed that some policymakers cautioned against a further increase in the bank’s emergency bond-purchasing programme.

Bank of America economists wrote in a note to clients that they had cut their euro area inflation forecast further, saying the upward pressures on prices that had emerged during lockdown have faded again.

The five-year, five-year forward – a key measure of euro zone inflation expectations – continued to dip down from its recent six-month highs.

BofA’s analysts also expect a top-up of the ECB’s emergency purchase programme, probably in December.

“That will be necessary to accommodate the economy,” they wrote. “But it will not suffice to tackle long-term inflation dynamics and faltering expectations. More and longer policy support is needed, urgently.”

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