Euro area yields rise, but head for second straight weekly fall

By Stefano Rebaudo

Feb 7 (Reuters) - Euro zone government bond yields rose on Friday after the release of U.S. economic data, but headed for the second straight weekly fall over concerns potential U.S. tariffs could deliver a deflationary shock to the European economy.

U.S. data showed January job growth slowed more than expected, following strong gains in the previous two months. However, the unemployment rate was steady at 4%, while hourly earnings showed significant increases.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, was up 2.5 basis points (bps) to 2.38%. It was set to end the week 6 bps lower after a fall of 8.5 bps the week before on weak economic data.

While markets price in 38 bps of Fed cuts in 2025 IRPR, which implies one 25 bps move and a 52% chance of a second cut, some analysts believe the Fed will not ease policy this year.

"With economic growth above trend and (U.S. President Donald) Trump policies adding to inflation risks, we see no reason for the Fed to cut rates further," said Atakan Bakiskan, U.S. economist at Berenberg.

Markets still fear Trump will impose import duties against the European Union, and analysts have said the demand shock facing euro zone exporters would be likely more significant than the inflationary effect of potential EU retaliatory tariffs.

Money markets priced in an ECB deposit facility rate at 1.9% in December EURESTECBM7X8=ICAP from 1.9% before U.S. data. It was at 1.95% late last week and dropped to 1.85% after Trump announced tariffs against China, Canada and Mexico.

The euro area neutral level for the deposit rate, which neither stimulates nor restricts growth, is seen at between 1.75% and 2.25%, the ECB said earlier in the session.

The ECB should stand ready to ease borrowing costs to a level lower than neutral to boost growth, ECB policymakers Olli Rehn and Mario Centeno said this week.

German two-year yields DE2YT=RR, more sensitive to European Central Bank rate expectations, rose 2 bps to 2.07%.

The yield spread between OATs and Bunds DE10FR10=RR - a market gauge of the risk premium investors demand to hold French debt - was at 71 bps, after the French Senate on Thursday approved the 2025 budget.

"We are at the bottom of the range of the past six months, so if there's volatility, the spread could widen," said Eliezer Ben Zimra, fixed income fund manager at Carmignac.

"Even if we have more government stability, we don't have any structural reform to reduce debt," he added, flagging that the yield gap could fluctuate between 70 and 100 bps.

The yield gap hit 69.60 bps on Wednesday, its tightest level since October 31. It widened to around 90 bps, its highest since 2012, in mid-January and end-November amid fears that France would be unable to cut its growing budget deficit.

Italy's 10-year yield IT10YT=RR was 4 bps higher at 3.48%, and the gap between Italian and German yields DE10IT10=RR stood at 107.5 bps.