UPDATE 1-Euro zone bond yields drop after weak PMIs

* German bond yields set for first daily drop this week

* Even as weak PMIs were slightly better than estimates

* U.S. stimulus unlikely to drive European bonds for long (Recasts, rewrites throughout, adds details)

By Yoruk Bahceli

AMSTERDAM, Dec 3 (Reuters) - Euro zone government bonds yields dropped on Thursday as weak business activity readings drew attention away from the stimulus negotiations in the United States which could ultimately signal brighter prospects for the global economy.

Hopes of a new stimulus package to help the U.S. economy hit Treasuries in recent sessions, with longer-dated borrowing costs rising in anticipation of the new borrowing and the gap between shorter- and longer-dated borrowing costs growing to its highest since 2018.

That also drove euro zone bond yields higher this week, although less than in the United States, as Europe's economic recovery is expected to be more difficult and the European Central Bank is largely expected to add to its stimulus next week.

But European yields dipped on Thursday, even as data showing business activity contracting in the euro zone during the November lockdowns showed a slightly smaller contraction than predicted by earlier flash estimates.

German yields were set for their first daily fall this week, with 10-year yields down 3 basis points to -0.55%.

Southern European bond yields also fell. Italy's 10-year yield was down 3 basis points to 0.58%, while Portugal's 10-year yield fell similarly to around 0.05%, heading back towards 0%.

A key market gauge of long-term euro zone inflation expectations dipped to around 1.24% after briefly rising to its highest since February, at 1.2559%.

Noting that the weak PMIs were not a surprise and were actually better than initial expectations, Richard McGuire, head of rates research at Rabobank in London, said the fall in German yields was likely a retracement of the rise earlier this week, rather than driven by economic fundamentals.

Other headlines casting a gloomy outlook were Germany's announcement late on Wednesday it will extend restrictions to stem the new wave of COVID-19, originally due to expire on Dec. 20, until Jan. 10. Italy said it will impose movement restrictions during Christmas; its prime minister is expected to give further details on Thursday.

European bond markets are likely to remain steady as stimulus negotiations drive U.S. Treasuries given the outlook for next week's ECB meeting, said Annalisa Piazza, fixed income analyst at MFS Investment Management.

"Of course, there is a directionality that also comes from the U.S. and speculation that the U.S. could do more fiscal policy that could lead to a bit of a steepening not just into year end, but could be amplified by some profit taking," Piazza said. "We cannot rule out a slight steepening of the (yield) curve, but this is not going to take yields much higher than they are now." (Reporting by Yoruk Bahceli; Editing by Alison Williams)