Euro area yields drop after US-EU trade deal, Fed, BoJ, data in focus

By Stefano Rebaudo

July 28 (Reuters) - Euro area government bond yields dropped on Monday after a trade agreement between the U.S. and the European Union introduced a 15% U.S. import tariff on most EU goods, broadly in line with economists' forecasts.

Expectations of a tariff deal and a hawkish tilt from the European Central Bank prompted investors to scale back bets on future rate cuts last week, pricing in just a 60% chance of a 25 bps easing move by December.

However, ECB policymakers appeared to temper market bets on no more rate cuts the day after the central bank meeting.

Investors were staying on the sidelines at the start of a week packed with central bank policy meetings — including the Federal Reserve and the Bank of Japan — and key economic data releases from the U.S. and the euro area.

Germany's 10-year government bond yield DE10YT=RR, the euro area's benchmark, was down 2 basis points (bps) at 2.70%, after rising more than 10 bps in the last two sessions.

While roughly in line with reports from last week, the U.S.-EU trade deal removed near-term "no deal" and higher tariff scenarios.

"Mutually disruptive escalation and retaliation between two global trade heavyweights will be avoided," said Mark Wall, chief euro area economist at Deutsche Bank.

Some economists argued that the deflationary impact of a 30% tariff on EU goods - the rate U.S. President Donald Trump had threatened to impose without a deal - could have prompted the ECB to cut its deposit rate to 1.5% from the current 2%.

Markets are pricing an ECB depo rate at 1.84% by December EURESTECBM3X4=ICAP -- implying a 65% chance of a rate cut by December -- from 1.85% late Friday and 1.78% before the ECB statement on Thursday.

They indicated a depo rate at 1.73% early last week, before a U.S.-Japan trade deal helped ease fears over the recessionary impact of a trade war.

The Bank of Japan is set to hold off raising interest rates on Thursday but may signal rate hikes later this year, after the trade agreement.

Trump said on Friday he had a good meeting with Fed Chair Jerome Powell and got the impression that the head of the U.S. central bank might be ready to lower rates. Markets still expect rates unchanged.

German 2-year government bond yields DE2YT=RR – more sensitive to expectations for European Central Bank policy rates – fell 1.5 basis points (bps) to 1.92%.

Italy's 10-year government bond yields IT10YT=RR were down 3 bps at 3.55%, with the spread between BTP and Bund yields - a market gauge of the risk premium investors demand to hold Italian debt - at 85.5 bps. It hit 84.20 bps in June, its lowest since March 2015.