Euro zone yields edge down after hitting multi-week highs, await US data

By Stefano Rebaudo

May 14 (Reuters) - Euro zone yields retreated on Wednesday, pulling back from multi-week highs reached earlier in the session amid easing trade tensions, as investors await key U.S. economic figures.

The data calendar was thin on Wednesday, but markets expect Thursday's U.S. reports to provide further insight into the impact of the initial phase of tariffs.

Investors were assessing the potential effects of the U.S.-China deal while concerned that the aggressive trade policy announced by U.S. President Donald Trump in early April has fuelled U.S. inflation and damaged global growth.

"Not only is this reduction (of U.S. China trade duties) temporary, but it still maintains tariffs at a very high level, since the average rate on all Chinese products is still around 40%, versus 20% previously," said Nabil Milali, portfolio manager at Edmond de Rothschild Asset Management.

Milali also mentioned "the risk of a deterioration in growth linked to trade uncertainty, the inflationary risk and the Federal Reserve's prolonged pause" as factors that could hurt market sentiment.

Euro area borrowing costs jumped on Monday following U.S.-China talks and comments from European Central Bank board member Isabel Schnabel suggesting the ECB should stop cutting rates.

Germany's 10-year yield DE10YT=RR, the euro area's benchmark, dropped 1.5 basis points (bps) to 2.66% after hitting 2.694%, its highest level since April 10.

"We expect euro area longer-dated yields to remain elevated, first driven by easing trade tensions, with additional upward pressure likely from increased bond issuance in the coming months," said Michiel Tukker, rate strategist at ING, after mentioning Germany's big spending programme.

Money markets priced in the European Central Bank deposit facility rate to be at 1.79% by year-end EURESTECBM5X6=ICAP, up from 1.67% late Friday and from below 1.55% after the ECB suggested in mid-April it will cut rates in response to a possible tariff-induced economic slowdown.

They also indicated an almost 95% chance of a rate cut in June and about a 10% chance of a second easing move in July.

ECB policymaker Francois Villeroy de Galhau said there was room for another rate cut by the summer, while ECB's Joachim Nagel saw a "good probability" inflation would converge towards the target of around 2%.

German inflation eased further to 2.2% in April, confirming preliminary data.

U.S. Treasury yields dropped in London trade – with the 10-year US10YT=RR down 5 bps at 4.45% - after rising the day before as investors worried about inflation picking up in the coming months.

German 2-year yields DE2YT=RR, more sensitive to ECB policy rates, fell 1.5 bps at 1.92%.

Italy's 10-year yield was down 3 bps at 3.67% IT10YT=RR, after reaching 3.713%, its highest since April 14.

The spread between Italian and German yields – a market gauge of the risk premium investors demand to hold Italian debt – was at 99 bps DE10IT10=RR, after reaching 93.80 the day before, its lowest since April 2021.