UPDATE 1-Euro, German bond yields drop as surveys signal slowing growth

The euro fell and the bloc's government bond yields dropped on Wednesday after data showed business growth in the single currency area lost far more momentum than expected, as trade tensions and worries over Italy overshadow the economy.

A survey showed euro zone business growth decelerated faster than anticipated as the final quarter of 2018 began, dragged down by waning orders that dented confidence, a survey showed on Wednesday.

"The flash PMI (data) for October gives a first glimpse of where the eurozone economy is heading. And the picture is not terrific," ING economist Peter Vanden Houte said in a note.

The data for the bloc as a whole came after French and German business surveys also undershot expectations when released earlier.

The euro extended its losses on the back of the figures, falling half a per cent to $1.1417, its lowest since Aug. 20. It was already down about 0.4 per cent after the German and French surveys.

Germany's 10-year bond yield dropped to the day's low of 0.39 per cent, down 2.4 bps on day, while other high-grade euro zone bond yields were also lower.

"It's true that the wider eurozone figures were below expectations, and the fact that the services sector is falling as well is a bit troublesome," said Natixis strategist Cyril Regnat.

"We keep having downside risks on growth ... I do feel the ECB will say the trade war issue and global downside risks are gently weighing on confidence, but their statement about growth should probably remain unchanged," Regnat said.

The European Central Bank is due to meet on Thursday, when its president Mario Draghi may hint at how concerns over Italy's budget and the equity market downturns will affect monetary policy.

"Besides risk sentiment, economic sentiment should be key today as both can influence the tone at tomorrow's ECB meeting," Commerzbank analysts said in a note to clients.

DIFFICULT PERIOD

Italian government bonds edged off the previous day's highs as a recovery in European stocks improved risk sentiment, though analysts warned the country has a difficult period coming up.

Italian borrowing costs were down between 1.5 and 2 basis points across the curve, down from the weekly highs they reached on Tuesday after the European Union rejected Italy's draft budget for 2019.,

Analysts attribute the recovery to an upswing in risk sentiment following a late rally in Wall Street and a corresponding boost for European shares Wednesday morning, after a difficult few weeks for the stock market.

"The slight improvement in risk sentiment in equity markets could be feeding through, but it's going to be a tough week for the (Italy/Germany) spread," said ING strategist Martin Van Vliet. "Many investors are going to remain on the sidelines until the S&P decision."

S&P Global is due on Friday to review Italy's credit rating, currently at BBB with a stable outlook.

Analysts expect a downgrade but are divided on whether this will only be for the outlook, moving to "negative", or whether the agency will drop Italy's credit rating by a notch to BBB-, the lowest investment-grade rating.