Markets price in 50% chance of four ECB cuts in 2025 on weak economy

Updates in afternoon trading in Europe

By Stefano Rebaudo and Harry Robertson

Feb 28 (Reuters) - German short-dated yields fell to a 10-week low on Friday as traders increased their bets on rate cuts on the back of weak data, but later recovered ground as investors digested slightly stronger German inflation figures.

Data on Friday showed French inflation unexpectedly dropped below 1% for the first time in four years in February. Separate European Central Bank survey data showed euro zone consumers lowered their near-term inflation expectations last month but continued to see economic contraction ahead.

Traders moved to price in a 50% chance of a fourth easing move amid concerns about the bloc's economy.

Germany’s 2-year government bond yield DE2YT=RR, more sensitive to European Central Bank policy rates, hit 1.999%, its lowest level since Dec. 20, before bouncing back to %2.025, still down a basis point (bp) on the day.

Money markets priced in an ECB deposit rate at around 1.88% in December EURESTECBM7X8=ICAP from the current 2.75%, implying three 25 bps rate cuts and about a 50% chance of a fourth move. They priced a depo rate at 1.97% last week.

However, yields and ECB pricing rose somewhat after figures showed German inflation came in slightly stronger than expected in January at 2.8% year-on-year, even after inflation eased in four sizeable German states.

The barrage of price data continued with a reading of U.S. personal consumption expenditures (PCE) inflation - closely watched by the Federal Reserve - which continued to cool in line with expectations in January.

Germany's 10-year government bond yield DE10YT=RR, the benchmark for the broader euro zone, was last down 2 bps at 2.396%.

Also on the radar was U.S. President Donald Trump's floating of a 25% "reciprocal" tariff on European cars and other goods on Wednesday, sparking renewed worries about a possible trade war.

"The specific mentioning of the auto sector (in possible U.S. tariffs against Europe) could also mean a repeat of the 2018 tariff threat against that sector only," said Citi.

"This makes a difference for the size of the impact - car exports are only 10% of total European Union (EU) exports to the U.S. - and the distribution of losses against EU member states," it added.

Euro area borrowing costs fell after the German election on Sunday as winner Friedrich Merz ruled out a quick reform to state borrowing limits.

Analysts said an increase in Germany's fiscal spending could boost the euro area's economy.

The ECB will meet next week, with investors widely expecting a 25 bps rate cut.

"The critical communication to watch next week is whether the ECB drops the 'restrictive' label from its official stance," said Carsten Brzeski, global head of macro at ING, recalling that hawkish ECB officials, including Isabel Schnabel, have started to push back against additional rate cuts.

"If it does, a pause in the rate cut cycle could become an option. If not, the current pace of rate cuts will continue."

Most analysts believe that the structural weakness of the economy, looming tariffs and low inflationary pressure will force the ECB to cut rates to at least 2%, even if not all the ECB members would like that.

Italy's 10-year yield IT10YT=RR was down 1 bp at 3.478%. The yield gap between Italian and German government bonds DE10IT10=RR was 108 bps.