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Fed's inflation conundrum firms demand for government bonds

[LONDON] Most eurozone government bond yields fell on Thursday, tracking an earlier move in US Treasuries after minutes of the Federal Reserve's last meeting showed some policymakers called for halting interest rate hikes until inflation improves.

Details of the July meeting, released late Wednesday, showed concerns that recent soft inflation data may cool the pace of monetary tightening in the world's largest economy despite moderate growth and very low unemployment.

The Fed has raised its benchmark overnight lending rate twice this year and forecasts one more rise before the end of 2017.

But money markets pricing suggests investors now see less than a 50 per cent chance of a hike by December.

"Fed communications are cementing expectations of a very gradual approach to monetary tightening," Mizuho's head of euro rates strategy Peter Chatwell said.

Signs of the central bank's caution came as President Donald Trump dissolved two business advisory group, sowing further doubts over his ability to deliver growth-boosting spending plans he promised when elected.

The Fed is not the only central bank wary of weak inflation.

Reuters reported on Wednesday that European Central Bank President Mario Draghi will not deliver a new policy message at next week's Jackson Hole conference, tempering expectations for the bank to start charting its course out of stimulus.

US 10-year yields, which had climbed to one-week peaks earlier on Wednesday, fell after the minutes and eventually closed down four basis points on the day at around 2.23 per cent .

When European markets opened on Thursday, benchmark German equivalents fell nearly two basis point to 0.42 per cent , coming off Wednesday's high of 0.47 per cent.

Most other eurozone yields fell between one to two basis points.

In an interview with Reuters on Wednesday, Cleveland Fed President Loretta Mester staked out the hawkish argument for carrying on with US interest rate hikes even while weak inflation has split opinions among her colleagues.

She said while some price readings have fallen this year, expectations are more stable, and that policy must anticipate changes in the data and not react to temporary aberrations.

San Francisco Federal Reserve President John Williams, a non-voter, said the Fed is roughly at the mid-point on its current path to normalise interest rates. The Fed has raised key overnight borrowing costs four times since December 2015.