(Updates in late morning trading in Europe)

By Harry Robertson

LONDON, Dec 16 (Reuters) - Euro zone government bond

yields held steady on Monday through a barrage of European

economic data which continued to point to a tepid economy and

dwindling inflation.

The risk premium on French government debt rose to its

highest in a week after Moody's unexpectedly downgraded France's

credit rating on Friday, before narrowing slightly.

Germany's 10-year bond yield, the euro zone

benchmark, was flat at 2.245%. Yields move inversely to prices.

Data on Monday showed the decline in euro zone business

activity eased slightly this month, with services perking up.

"The detail shows that demand remained under pressure at the

end of the year, and so output was scaled back and the majority

of firms decided not to hire new staff," said Melanie Debono,

senior Europe economist at Pantheon Macroeconomics.

Europe's labour markets softened in the third quarter, while

Italian inflation was slightly weaker than expected in November.

Investors were also digesting comments from European Central

Bank President Christine Lagarde, who flagged further rate cuts.

"If the incoming data continue to confirm our baseline, the

direction of travel is clear and we expect to lower interest

rates further," Lagarde said in a speech in Vilnius.

Bond yields wavered slightly, but were last trading broadly

flat from Friday's close. The yield on France's 10-year bond

rose 1 basis point (bp) to 3.036%.

The gap between French and German yields - seen as a gauge

of the extra return investors demand to hold France's debt -

earlier rose to 80 bps, its highest since Dec. 5.

The Moody's downgrade adds to the pressure on new prime

minister Francois Bayrou, who must corral divided lawmakers into

backing his efforts to rein in strained public finances.

The main event of the week is Wednesday's U.S. interest rate

decision, with the Fed expected to lower rates by 25 bps.

A tough stance from the Fed on future rate cuts could dent

U.S. bond markets, potentially spilling over into Europe.

Italy's 10-year yield was up 1 bp at 3.395%, and

the gap between Italian and German yields 115 bps.

Germany's two-year bond yield, which is more

sensitive to ECB rate expectations, slipped 1 bp to 2.049%.