UPDATE 2-German 10-year yield set for biggest daily drop in 8 months

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By Yoruk Bahceli

Oct 27 (Reuters) - Germany's 10-year government bond yield slipped on Wednesday with benchmark yields set for their biggest daily drop in eight months, as investors weighed the prospects of slowing economic growth and soaring market-implied gauges of inflation.

After a brief pause, global government bond yield curves have resumed their flattening trend, a move that reflects growing concern that central banks, particularly the Bank of England, might commit a policy error if they tighten policy too early on the back of high inflation levels that may prove temporary.

Germany's 10-year yield, a benchmark for the bloc, fell to the lowest in more than a week at -0.168%, falling alongside U.S. Treasury and British gilt yields, and was down 6 bps on the day, on track for its biggest daily drop since end-February.

The yield curve flattened as 30-year yields fell more than 8 bps to 0.16%, the lowest in five weeks.

A key market gauge of long-term euro zone inflation expectations - the five-year five-year breakeven forward - briefly hit a seven-year high at 2.0951%, continuing to hold above the ECB's 2% target.

"With rising infections, slowdown in PMIs ... having a very narrow inflation focus may not be the best ... insisting on raising rates, when the factors that have driven inflation upwards are supply-related rather than demand-related," said Jens Peter Sorensen, chief analyst at Danske Bank.

"I guess the markets are beginning to acknowledge this."

The "real" yield on Germany's 10-year inflation-linked bond fell further to a new record low at -2.051%.

Focus is also on Thursday's ECB meeting, where the bank is expected to keep policy unchanged and leave a decision on its pandemic emergency bond purchase programme to December.

But President Christine Lagarde is expected to push back on market pricing given the surge in inflation expectations and a rate hike priced in for next year that is at odds with the ECB's economic projections.

"The ECB is not going to be raising rates next year ... If they still believe that then they have to say it quite forcefully and that should bring a bit of relief," Chris Iggo, chief investment officer for core investments at AXA Investment Managers, said.

While Iggo acknowledged that some ECB policymakers have pushed back against market pricing, "it needs to be done at a policy press conference by Lagarde, it needs to be quite forceful," he said.

In the primary market, Germany raised 1.509 billion euros from a re-opening of a 15-year bond.

The auction was a technical failure as it received 1.925 billion euros of demand, less than the 2 billion euros Germany was targetting. It is the third technical failure in a row at German auctions.

"I think it is a bit of a worry. Not in the sense that they will fail to find demand for debt sales, but in the sense that demand for low-yielding debt is waning going into a global central bank tightening cycle," said Antoine Bouvet, a senior rates strategist at ING. (Reporting by Yoruk Bahceli; Editing by Alexander Smith, David Holmes, William Maclean)

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