Euro zone bonds recover from post-U.S. payrolls selloff

LONDON, Aug 8 (Reuters) - Euro zone bond yields fell on Monday, having risen sharply after stronger-than-expected U.S. jobs data at the end of last week, while Italian bonds appeared to brush off a decision by Moody's to lower Italy's ratings outlook.

Safe-haven bonds also drew support from geopolitical tensions. China's military announced fresh drills on Monday in the seas and airspace around Taiwan - a day after the scheduled end of its largest ever exercises to protest against last week's visit to Taipei by U.S. House Speaker Nancy Pelosi.

Germany's 10-year Bund yield was down 5 bps at 0.90% .

It rose 15 bps on Friday in its biggest one-day surge since March 2020. This move followed data showing the U.S. economy created 528,000 new jobs in July, which stoked expectations for a supersized September U.S. rate hike and pushed up Treasury yields 10-22 basis points (bps).

French and Dutch 10-year bond yields were also 5 bps lower on the day after rising sharply on Friday.

A rise in U.S. rate-hike bets for September also boosted bets for another big rate rise from the European Central Bank next month.

Money markets now price in about a 90% chance of a 50 bps rate rise from the ECB in September, up from around a 50% chance a week ago.

Italian bonds underperformed their peers, with 10-year Italian bond yields just 1 bps lower at 3.01%.

Italy's closely watched bond yield gap over top-rated Germany was at around 211 bps, versus 205 bps late on Friday.

Ratings agency Moody's cut Italy's outlook to "negative" from "stable" on Friday, weeks after Prime Minister Mario Draghi's resignation sparked fresh political uncertainty.

Moody's said risks to Italy's credit profile had risen due to political developments and the economic fallout of Russia's invasion of Ukraine.

S&P Global last month cut its ratings outlook to stable from positive, citing concern that political instability could slow the path for key economic reforms.

"The same rating action by S&P the other week already prepared markets for a less dovish rating dynamics but failed to cause lasting pressure," said Michael Leister, head of interest rates strategy at Commerzbank.

"We expect BTPs to continue to grind tighter," he said, referring to the Italian bond spread over Italy.

Data last week showing the ECB had skewed reinvestments from maturing bonds from its PEPP stimulus scheme to Italy was expected to bolster Italian debt. (Reporting by Dhara Ranasinghe; Editing by Susan Fenton)