Markets price out ECB rate cut this year, German 2-year yield hits three-month high

LONDON, July 31 (Reuters) - Money markets pared back bets on European Central Bank rate cuts on Thursday and now expect no more ECB easing this year, pushing Germany's rate sensitive two-year yield to a three-month high.

Markets now see just a 44% chance of a 25 basis point ECB rate cut this year EURESTECBM3X4=ICAP, having seen a 25 bp cut as all but certain last week before the announcement of the EU-U.S. trade deal and the ECB meeting.

At that meeting, the central bank left interest rates unchanged and offered a modestly upbeat assessment of the euro zone economy, though markets largely reacted to a press conference from ECB president Christine Lagarde in which she suggested that the bar for further cuts is high.

Germany's two-year yield rose nearly three basis points on Thursday to as high as 1.965%, its highest since early April. DE2YT=RR

Rohan Khanna, head of euro rates strategy at Barclays, said that at the press conference Lagarde had sounded dismissive of any factor that could put a dovish spin on the bank's policy path.

Thursday inflation data from some of the euro zone's biggest economies also gave no reason for further rate cuts, showing price rises at or just above expectations this month, suggesting Friday's bloc-wide data will hold near the ECB's 2% target.

Some policy makers had expressed concern last month that inflation could dip significantly below that target, necessitating further rate cuts, but these fears look less likely to be realised.

Longer dated bond yields dipped slightly, however, causing curves to flatten in market parlance.

Germany's 10-year bond yield, the benchmark for the euro zone, dropped around 1 basis point to 2.70%, reversing a small move the day before. DE10YT=RR

It is now around 73 bps higher than the two-year yield, making the curve its flattest in a month, albeit after substantial steepening this year. DE2D10=RR

Longer dated bonds were helped at the margin by a small decline in longer dated Japanese yields after a Bank of Japan policy statement caused market participants to push out expectations for any future interest rate hike. JP/

Still to come is U.S. PCE inflation data, the Federal Reserve's preferred inflation gauge, which is due at 1230 GMT. It is probably more important for markets than European inflation data now that is around target.

The Fed kept rates on hold on Wednesday and said it was still in the early stages of understanding how President Donald Trump's policies, including on trade, will affect inflation, jobs and economic growth.

Other moves were largely in line with the German benchmark. Italy's 10-year yield was down 1 bps at 3.54%, maintaining its gap with Germany at 82.4 bps, holding around its tightest in years. IT10YT=RR, DE10IT10=RR