Bund yields hit fresh 2-month high before German inflation data

By Stefano Rebaudo

Jan 6 (Reuters) - Euro zone benchmark Bund yields hit a fresh two-month high on Monday, with markets scaling back bets on European Central Bank rate cuts ahead of the release of German inflation data.

The consumer price index of the German state of Hesse rose 2.7% year-on-year. National data will be released later in the session.

Euro area borrowing costs increased on Friday after data showed German unemployment rose less than expected in December.

Germany's 10-year government bond yield DE10YT=RR was up 2 basis points (bps) to 2.44% after hitting 2.457%, its highest level since Nov. 7.

A stronger economy could lead the European Central Bank to be more cautious when it comes to interest rate cuts.

Germany's 2-year yield DE2YT=RR, which is more sensitive to expectations for ECB rates, rose 1.5 bps to 2.18%, after reaching 2.213%, its highest since Nov. 8.

The euro zone labour market's exceptional resilience is unlikely to last, although there is also no dramatic weakening on the horizon, ECB research showed on Monday.

Markets priced in an ECB deposit facility rate at 2.1% in July 2025. This compares with 2.05% late on Friday and 1.9% before Christmas. EURESTECBM5X6=ICAP The depo rate is currently at 3%.

Analysts flagged that ECB policymaker Yannis Stournaras, one of the more dovish council members, said last week he expected the bank's main interest rate to be cut to 2% by the autumn.

Government bond supply is also in the spotlight, with Citi forecasting gross issuance from the first 11 countries which adopted the euro (EMU-11) in 2025 to be 45 billion below the record high seen in 2024.

"The decrease in supply is largely driven by Germany, Italy and Spain, while France, net of buybacks, and Portugal should see an increase," said Puja V Sawant, strategist at Citi.

The closely watched gap between French and German bond yields - a gauge of the premium investors demand to hold French debt – was at 83.5 bps. DE10FR10=RR

It jumped to around 90 bps in the summer as elections plunged France into political turmoil and raised fears that it could struggle to curb a burgeoning public deficit.

France failed to approve a budget for 2025 before an end-of-year deadline, and President Emanuel Macron had to name his fourth prime minister of 2024 in December.

Finance Minister Eric Lombard said on Monday that the 2025 budget bill targeted 50 billion euros in cost savings - a lower figure compared to those targeted by the previous government.

Italy's 10-year yield IT10YT=RR dropped one bp to 3.59%, after hitting 3.61%, its highest since Nov. 21. The gap between Italian and German yields DE10IT10=RR tightened to 114 bps.

(Reporting by Stefano Rebaudo, editing by Gareth Jones)

((stefano.rebaudo@tr.com))