Bund yields on track for first weekly drop since early December

Updates prices in late European trading

By Stefano Rebaudo

Jan 17 (Reuters) - Euro zone benchmark German bond yields were on track to record their first weekly drop since early December 2024 as U.S. inflation data drove borrowing costs lower on both sides of the Atlantic.

Several analysts said that U.S. figures released on Wednesday were weaker than expected but not enough to challenge the view that the Federal Reserve will remain on hold for now and wait for more data and fiscal policy clarity.

However, Federal Reserve Governor Christopher Waller said on Thursday that inflation would likely continue to ease and possibly allow the U.S. central bank to cut interest rates sooner and faster than expected.

Investors closely watched U.S. Treasury yields which were little changed on Friday after dropping the day before.

Germany's 10-year bond yield DE10YT=RR was down 2.8 basis points at 2.494% and was about to record a 7 bps weekly drop.

"While inflation is sticky in the U.S., it is coming off hard in the rest of the world, not least because of China," UBS rate strategists said in a research note.

"As it gains share in stalled global exports, it puts strain on exports of other emerging markets and developed markets, pushing their currencies and rates lower," they added, recommending being long Bunds.

Germany's two-year yield DE2YT=RR, more sensitive to European Central Bank rate expectations, fell 1 bp to 2.221%, on track for a 6 bps weekly drop.

Analysts noted that the front-end was well priced in the euro area as markets have been discounting around 100 bps of ECB rate cuts in 2025 for a while.

The ECB needed to cut interest rates cautiously, but further policy easing was likely coming given weakening price pressures, policymakers concluded last month, according to the accounts of their Dec. 11-12 meeting.

Money markets show the ECB deposit facility rate at over 2% at the end of 2025. EURESTECBM8X9=ICAP.

Italy's 10-year yield IT10YT=RR was 2.5 bps lower at 3.632%. It outperformed Germany, with the yield set for a 14 bps weekly fall. Bond prices move inversely to yields.

The gap between Italian and German yields DE10IT10=RR - a gauge of the risk premium investors demand to hold Italian debt - stood at 114 bps. It hit 104.5 bps in early December, its tightest level since October 2021.

Government bonds of Southern European countries have outperformed Germany as their economies are doing well while the governments maintain fiscal discipline.

The yield spread between French and German yields DE10FR10=RR tightened one bp to 80 bps after Prime Minister Francois Bayrou passed the first test of his new minority government. Bayrou still faces an uphill battle to pass the 2025 budget aimed at cutting a burgeoning budget deficit.

(Reporting by Stefano Rebaudo; Editing by Emelia Sithole-Matarise and Alison Williams)

((stefano.rebaudo@tr.com))