* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr (Recasts after payrolls, updates price action) MILAN, July 2 (Reuters) - Euro zone government bond yields fell on Friday, as strong U.S. economic data failed to tempt investors out of the safety of fixed income given concerns about the COVID-19 variant and confidence that the ECB will keep policy support in place. Benchmark German Bund yields, down 8 basis points this week, were set for their biggest weekly drop since December, while the yield on the European Union’s new 10-year recovery fund bond dipped below 0% for the first time. Italy’s 10-year bond yield meanwhile was poised for its biggest weekly drop in a year, down 15 bps this week, as European Central Bank President Christine Lagarde confirmed the bank’s dovish stance. She said the euro zone’s economy is beginning to rebound from a pandemic-induced slump but this recovery remains fragile. Meanwhile, concerns about the impact on the global economy of a possible monetary tightening in China and of the Delta variant of the coronavirus kept risk sentiment on hold. “Yields are dropping across euro fixed income markets,” said ING senior rates strategist Antoine Bouvet, citing a number of reasons such as a dovish European Central Bank tone and caution about the economic outlook due to the COVID-19 resurgence. Germany’s 10-year bond yield, the benchmark of the bloc, dropped 3.5 bps to -0.20%, its lowest level since mid-June. It was set for the biggest weekly fall since December. The yield on a new 10-year bond issued by the European Union last month to back the bloc’s recovery fund fell below 0% for the first time. It was last trading at 0.01%, down 2 bps, after falling to as low as -0.001%. Italy’s 10-year government bond yield was down 2.5 bps on the day at 0.79%, having fallen to as low as 0.768% -- its lowest since mid-June. Data meanwhile showed U.S. nonfarm payrolls increased by 850,000 jobs last month, while economists polled by Reuters had forecast payrolls advancing by 700,000. The Fed has been focusing on the labour market’s recovery and inflation when deciding its policy stance, and most analysts think it will take a couple more months before those trajectories become more evident. U.S. jobs data should have been “way off consensus for it to affect the market. Otherwise, I think the current stabilization phase will continue,” Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors, said. Euro zone government bond and European Union supply “is likely to increase in 2022”, Citi analysts meanwhile said. “To keep annual net cash requirement unchanged the Asset Purchase Programme (APP) will need to be increased to €55bn per month after PEPP (Pandemic Emergency Purchase Programme) ends for EGBs (Euro zone government bonds) and significantly more for EU.” The Survey of Monetary Analysts published by the ECB in June predicted that the ECB would not step up buys under a more standard Asset Purchase Programme to compensate for the lost stimulus when the PEPP ends. Besides, it forecast APP purchase volumes would remain at 20 billion euros a month throughout next year and would end in December 2023. Reporting by Stefano Rebaudo and Dhara Ranasinghe, editing by Philippa Fletcher Our Standards: The Thomson Reuters Trust Principles.