By Harry Robertson
LONDON, April 25 (Reuters) - Euro zone government bond yields fell on Tuesday as investors remained on edge about the state of the economy ahead of the European Central Bank's interest rate decision next week.
Germany's 10-year bond yield, the euro zone benchmark, was last down 4 basis points (bps) at 2.448%. Yields move inversely to prices.
The yield was around 30 bps lower than the almost 12-year high of 2.77% hit in early March. But it was roughly 50 bps higher than the low reached during the banking jitters in the middle of last month.
Antoine Bouvet, senior rates strategist at Dutch bank ING, said Tuesday's drop in yields was likely driven by a sharp fall in Spanish producer inflation.
Spain's industrial price index dropped 1% in March in a sudden reversal driven by falling energy prices. "The magnitude comes as a surprise," Bouvet said.
Other analysts said the fall in yields was part of a general "risk-off" day in markets. Jussi Hiljanen, head of European rates strategy at lender SEB, said bank earnings were likely worrying investors.
U.S. lender First Republic was down 18% on Tuesday in Frankfurt after it said deposits plunged by more than $100 billion in the first quarter.
UBS shares were 4% lower after it set aside more money to deal with its involvement in toxic mortgages and flagged "challenging" economic conditions.
The German 2-year bond yield, which is highly sensitive to interest rate expectations, was down 4 bps to 2.913%.
It picked up late on Monday to finish around 4 bps higher after ECB policymaker Isabel Schnabel raised the prospect of a 50 bp increase in interest rates next week.
She told Politico that "data dependence means that 50 basis points are not off the table".
The ECB meets to decide interest rates on May 4. It raised its key rate by 50 bps last month to 3% despite the banking worries.
Economists polled by Reuters expect the ECB to hike by 25 bps, and then to take the main rate to 3.5% or higher in subsequent meetings.
Schnabel's colleague, France's Francois Villeroy de Galhau, struck a more cautious tone, saying on Monday that any further hikes need to be limited in number and size.
Italy's 10-year yield was down 3 bps at 4.332%. The closely watched gap between German and Italian 10-year borrowing costs held steady at around 188 bps.
ECB officials will look closely at the euro zone's first-quarter gross domestic product figures, due on Friday. Also due that day are inflation numbers from Germany, Spain and France.
Inflation numbers for the euro zone as a whole are due next week, on Tuesday.
"There is a lot of back and forth between the (ECB) hawks and the doves so that makes future policy meetings really interesting," said Joann Spadigam, rates strategist at NatWest.
"We do think that inflation is coming down so a 50 bp hike is not warranted at this point."
(Reporting by Harry Robertson; Editing by Simon Cameron-Moore)
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