Euro zone bond yields edge down, eyes on German climate package

Most euro zone government bond yields edged down on Friday as fresh frictions in the Middle East and a cut in a key Chinese lending rate bolstered demand for fixed income. Iran warned U.S. President Donald Trump on Thursday against being dragged into war after an attack on Saudi Arabian oil facilities that Washington and Riyadh blame on Tehran.

China meanwhile cut a key lending rate for the second straight month on Friday, a move that follows a U.S. rate cut on Wednesday and last week's reduction by the European Central Bank. Uncertainty also remains high on the trade and economic growth front. U.S. and Chinese deputy trade negotiators resumed face-to-face talks for the first time in nearly two months on Thursday ahead of high-level talks in early October.

And the German economy started the third quarter on a weaker footing, the Finance Ministry said overnight, with signs emerging of a future rise in unemployment. Long-dated bond yields were down 1 basis point across higher-rated euro zone government bonds .

Germany's benchmark 10-year Bund yield was about a basis point lower at -0.51%. "I was a little bit surprised that we have rising (bond prices) this morning; my backdrop was more risk-on environment," said DZ Bank rates strategist Rene Albrecht.

"There was a focus on monetary policy decisions this week and last week but politics is moving into the spotlight again. We have Brexit, Middle East tensions and trade talks (on the table), so it's better safe than sorry," he added. In the wake of last week's stimulus package from the ECB, southern European bonds have performed well.

Greece's 10-year bond yield on Friday hit a fresh record low at around 1.31%. A climate protection package expected from Germany was also in focus for further signs of fiscal stimulus from euro zone economies.

Sources have told Reuters that the package, which is in part aimed at stimulating innovation to reduce emissions, could cost at least 40 billion euros ($44 billion) by 2023. "It is important and a step in the right direction but the numbers and the timeline we're hearing is nothing significant that will have an impact on growth and inflation in the near-term," said Mohammed Kazmi, a portfolio manager at UBP, referring to the German climate package.

"Whether investors trade on the back of these headlines, not at this stage." Fiscal stimulus has been a key focus for bond markets since ECB chief Mario Draghi's news conference last week. Draghi repeatedly called for governments to do more to boost the bloc's long-term growth prospects, fuelling concern that ECB policy is reaching the limits of what it can achieve alone.

The Netherlands and Finland this week announced budgets that will step up government spending. ($1 = 0.9056 euros)