Euro bond yields drop as Trump's tariffs roil markets

Updates in late European trading

LONDON, Feb 3 (Reuters) - Euro zone bond yields fell sharply on Monday after U.S. President Donald Trump announced tariffs on Canada, Mexico and China and threatened more on Europe, pushing investors towards the safety of bonds on fears of a widespread trade war.

Yields retraced some of their drop later in the European session, however, when Mexican President Claudia Sheinbaum and Trump announced tariffs on Mexico would be paused for a month.

Germany's 10-year yield DE10YT=RR fell as much as 10 basis points to 2.359%, its lowest since Jan. 3, but last traded six bps lower at 2.398%. Yields move inversely to prices.

"On tariffs, the market is reading this as disinflationary. It sees this as a hit to economic growth in Canada and Europe," said Kenneth Broux, head of corporate research, FX and rates at Societe Generale.

On Sunday, Trump indicated the European Union would be next to face U.S. tariffs, but did not say when.

"He has said Europe would not escape tariffs, we are waiting for that," said Broux, who added the market moves reflected "a flight to quality and favourable inflation data cement(ing) the case for ECB rate cuts".

Markets breathed relief after Sheinbaum's and Trump's comments, with stocks recovering some lost ground and the Mexican peso and Canadian dollar rebounding sharply.

Market watchers were also digesting the latest euro zone inflation print, which showed prices accelerating slightly last month, but remaining on an anticipated course that could allow the ECB to cut rates further, possibly as soon as March.

It confirms soft inflation prints out of France and Germany on Friday.

The ECB cut borrowing costs for the fourth straight meeting last Thursday.

Traders on Monday were pricing in about 90 bps of further ECB interest rate cuts this year - taking rates to roughly 1.85% - compared to 80 bps of easing priced on Friday.

Germany's two-year bond yield DE2YT=RR was last down six bps at 2.055%, after falling to 2.01% earlier in the session, the lowest since Dec. 20.

Italy's 10-year yield IT10YT=RR was five bps lower at 3.512%, while France's 10-year yield FR10YT=RR was eight bps lower at 3.126%.

French Prime Minister Francois Bayrou said on Monday he was using special constitutional powers to pass the 2025 budget bill, a move likely to trigger a no-confidence vote that will decide whether his minority government survives.

The euro EUR=EBS was last down 0.5% at $1.0311, after earlier dropping as low as $1.0125.