Euro zone yields fall, markets boost bets on ECB rate cuts after US tariffs

By Stefano Rebaudo

April 3 (Reuters) - Euro area government bond yields dropped and markets increased their bets on future European Central Bank rate cuts on Thursday as the U.S. tariff announcement by President Donald Trump boosted fears of a trade war which would hurt global growth.

Money markets priced in a 90% chance of a 25 basis point bps ECB rate cut in April from around 80% the day before, and a depo rate at 1.8% in December from around 1.9%.

Trump on Wednesday unveiled sweeping global tariffs of at least 10% on goods imported from most U.S. trading partners. The EU faces tariffs of 20%.

ECB Vice President Luis de Guindos said on Thursday that economic uncertainty required extreme prudence, because trade barriers could toggle inflation in both directions.

Francois Villeroy de Galhau, an ECB policy maker, had said on Wednesday that the U.S. administration's tariff hikes should not derail an ongoing decline in inflation in Europe, and a recent fall boosted the case for a fresh interest rate cut.

But some experts were still worried about the impact on inflation: "While markets on both sides of the Atlantic are primarily concerned with growth risks right now, the implementation of tariffs poses a significant threat by pushing inflation upward," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

Germany's 10-year yield DE10YT=RR, the euro area's benchmark, fell 6 bps to 2.67%, after hitting 2.625%, its lowest since March 4.

On March 5, German yields recorded the biggest daily rise in decades as German parties reached an agreement for a massive ramp-up in fiscal spending on infrastructure and defence.

"We continue to see U.S. tariffs as a disinflationary shock for Europe, even with retaliation," said economists at Citi, adding that Ireland, Germany and Italy seem the most negatively exposed within the euro area countries.

"We expect a period of acrimonious relations, where retaliation is both more likely and more likely to escalate."

Analysts said that uncertainty about trade policies already weighed on growth.

German 2-year yields DE2YT=RR, more sensitive to the ECB policy rates, dropped 7.5 bps to 1.97%. It hit 1.924%, its lowest since December 12.

UBS expects the U.S. economy to grow closer to, or below, 1% and the Federal Reserve to cut rates by 75-100 bps in 2025.

"In the weeks ahead, we expect the White House's executive authority to be challenged in the courts," said Mark Haefele, chief investment officer at UBS Global Wealth Management, recalling Trump used the International Emergency Economic Powers Act (IEEPA), which hasn't previously been used to announce such sweeping changes to economic policy.

The yield gap between U.S. Treasuries and Bunds DE10US10=RR was at 141.3 bps after dropping briefly to 132.6 bps, its lowest since March 12.

U.S. Treasury yields dived to multi-month lows on Thursday after larger-than-expected U.S. tariffs boosted recession fears and sent investors into safe havens.

Some investors expected this spread to shrink further, luring more cash to Europe.

Italy's 10-year yields dropped 4 bps to 3.78%. The yield gap between BTPs and Bunds DE10IT10=RR -- a gauge of risk premium investors ask to hold Italian debt -- stood at 111 bps.

The yield gap between French and German bonds DE10FR10=RR was at 72 bps, after recently hitting its lowest levels since last summer at around 65 bps.