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 briefly increased their bets on future European Central Bank rate cuts on Thursday as the U.S. tariff announcement by President Donald Trump drove fears of a trade war which would hurt global growth.

Money markets at one point priced in a 90% chance of a 25 basis point ECB rate cut in April and a depo rate at 1.8% in December, but April pricing eased in the course of the day and was last around a two thirds chance.

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%.

Fears about the consequences of these tariffs for European and global growth sent investors rushing from equities to the safety of government bonds on Thursday.

Germany's 10-year yield DE10YT=RR, the euro area's benchmark, dropped to its lowest since March 4, and was last down 9 basis points at 2.636.

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.

The question for ECB policy makers is whether tariffs, as well as weighing on growth, will cause inflation to rise, requiring them to be more cautious about rate cuts.

"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.

EXTREME PRUDENCE

ECB Vice President Luis de Guindos said on Thursday that economic uncertainty required extreme prudence, because trade barriers could push inflation either higher or lower.

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 new interest rate cut.

German 2-year yields DE2YT=RR, more sensitive to the ECB policy rates, were last down 11 bps at 1.93%. Earlier they hit 1.919%, their lowest since December 12.

U.S. yields fell even more than European, with the U.S. 10- year yield down nearly 16 basis points. [US/]

That left the yield gap between U.S. Treasuries and Bunds DE10US10=RR at 141 bps.

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

This, however, depends in part on growth on either side of the Atlantic, central bank policy, and what ends up happening with the tariffs.

"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, noting Trump used the International Emergency Economic Powers Act (IEEPA), which has not previously been used to announce such sweeping changes to economic policy.

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.

Italy's 10-year yields dropped 4.5 bps to 3.77%. The yield gap between BTPs and Bunds DE10IT10=RR -- a gauge of risk premium investors ask to hold Italian debt -- stood at 112 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.