Bund yields at 2-month high, German inflation rises more than expected

Updates in European afternoon trade

By Stefano Rebaudo and Greta Rosen Fondahn

Jan 6 (Reuters) - Euro zone benchmark Bund yields climbed to their highest level in two months on Monday, after data showed German inflation rose more than expected in December, with markets scaling back bets on European Central Bank rate cuts.

German inflation rose more than forecast to 2.9% last month, preliminary data from the federal statistics office showed on Monday.

Analysts polled by Reuters had forecast a reading of 2.6% in December.

"The summer celebrations over successfully conquering the inflation monster were premature," said ING economist Carsten Brzeski.

Germany's 10-year government bond yield DE10YT=RR was up close to 4 basis points (bps) at 2.466%, its highest level since Nov. 7.

Investors now look ahead to Tuesday's euro zone inflation data release. This week's inflation data will be the last before the European Central Bank's next meeting on Jan. 30.

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

A stronger economy could lead the ECB 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 3 bps to 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.

The closely watched gap between French and German bond yields - a gauge of the premium investors demand to hold French debt – narrowed 2.5 bps to 81.3 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 was down one bps at 3.59%, after hitting 3.61%, its highest since Nov. 21. The gap between Italian and German yields DE10IT10=RR tightened to 112.2 bps.

(Reporting by Stefano Rebaudo and Greta Rosen Fondahn, editing by Gareth Jones and Franklin Paul)

((stefano.rebaudo@tr.com))