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For next ECB taper clues, euro zone bond markets look to the Fed

A trader works on the floor of the New York Stock Exchange (NYSE) as a television screen displays coverage of U.S. Federal Reserve Chairman Janet Yellen in New York, December 16, 2015. REUTERS/Lucas Jackson

By Dhara Ranasinghe and Abhinav Ramnarayan

LONDON (Reuters) - Euro zone government bond yields nudged down on Wednesday as investors awaited the conclusion of a U.S. Federal Reserve meeting for clues on whether another interest rate rise is likely this year.

Caught between a lull in U.S. inflation and a stronger global economy, the Fed is expected to signal whether it will raise rates for a third time this year or back off until prices rise more briskly.

What it says is important for the outlook for monetary policy in the euro zone, since any statement that points to another rate hike this year could lift the dollar against the euro (EUR=).

And any weakening in the single currency, up around 14 percent against the dollar this year, could encourage the European Central Bank to press ahead with plans to unwind its hefty stimulus scheme.

A strong euro, with its dampening effect on inflation, has clouded the outlook for ECB tapering.

ECB policymakers are divided on whether to set a definitive end-date for their stimulus scheme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, Reuters reported on Tuesday.

"The euro is still strong so that doesn't make life easier for the ECB," said Commerzbank rates strategist Rainer Guntermann. "If we move closer to a U.S. rate hike, that should come along with a bit more dollar strength and euro weakness which would harden the ECB's exit case and be a headwind for government bonds."

Most euro zone bond yields fell around 1-2 basis points on the day, with Germany's 10-year yield - the benchmark for the region - lower 1 basis point at 0.44 percent.

Spain was an underperformer on a day when concerns intensified around an independence referendum in the Spanish region of Catalonia.

Spanish police raided Catalan government offices and arrested officials on Wednesday to halt a banned referendum on independence, an action the regional president said meant Madrid had effectively taken over his administration.

The Spanish 10-year bond yield rose 2 basis points to 1.46 percent, and the spread over Germany widened out to 103 bps from 99 bps at the open.

It was a different story for neighbouring Portugal: its 10-year borrowing costs hit their lowest level since December 2015 at 2.387 percent , extending sharp falls seen after the country's return to investment grade with a major ratings agency.

German long-dated bond yields dipped after a 30-year bond auction.

The country's 30-year yields fell 2 bps to 1.23 percent .

(Reporting by Dhara Ranasinghe; Editing by Catherine Evans and Andrew Heavens)