Euro zone yields edge up after Fed, BoE decisions, Italy-France spread below zero

Sept 18 (Reuters) - Italy's bond yield fell below France's for the first time on Thursday, while euro area borrowing costs edged up, having offered little reaction to the Federal Reserve's decision to leave its interest rate outlook largely unchanged.

The U.S. central bank's decision to reduce rates by 25 basis points fell far short of the steep cut President Donald Trump had demanded, and which was apparently pencilled into projections submitted by new Fed Governor Stephen Miran, who cast the only dissenting vote against the policy decision.

Markets showed a muted initial response to the Bank of England's decision to keep rates unchanged on Thursday and to slow the pace of its quantitative tightening programme.

The release of stronger U.S. employment data in the European afternoon pushed up the dollar and triggered a broader sell-off in longer-dated bonds, analysts said.

Germany's 10-year government bond yield DE10YT=RR, the benchmark for the euro zone bloc, was up 3.8 basis points at 2.715%.

Market pricing for Fed rate cuts was little changed from pre-meeting levels, with traders still expecting 44 basis points of easing by the end of this year and 122 bps by the end of 2026. The current federal funds target range stands at 4.00%–4.25%.

ECONOMISTS THINK MARKET PRICING HAS GONE TOO FAR

However, economists still think the market pricing has gone too far in the Fed's monetary easing path.

"Rates are unlikely to fall further from there, as solid growth drives a rebound in labour market activity and causes inflation to rise," said David Rees, head of global economics at Schroders, after noting that he expects the Fed to deliver two more quarter-percentage-point cuts by the end of this year.

"As such, we continue to believe that market expectations of rates going below 3% are too aggressive," he added.

U.S. Treasury prices fell after the weekly unemployment data, which pushed yields up 4.8 bps to 4.122%.

Analysts suggested that Miran's lone dissent was no accident, but rather a calculated move by the rest of the policy-setting Federal Open Market Committee to show unity behind Fed Chair Jerome Powell and reinforce the central bank's institutional independence.

The yield gap between safe-haven Bunds and 10-year French government bonds DE10FR10=RR - a market gauge of the risk premium investors demand to hold French debt — was at 80 bps, not far from its six-month high of around 84 bps.

Italy's 10-year yields IT10YT=RR rose in line with those on the broader debt market, last up 4.4 bps at 3.54%. France's OAT yields stood at 3.52%, up 3.4 bps on the day.

Italy's 10-year yields dropped for the first time below France's earlier on Thursday FR10IT10=RR.

Markets are pricing in a 45% chance of a 25-bp rate cut by the European Central Bank by June 2026 EURESTECBM7X8=ICAP, which would bring its deposit rate to 1.75%. The key rate is seen at 1.95% by December 2026. EURESTECBM11X12=ICAP

Germany's 2-year yields DE2YT=RR, more sensitive to expectations for ECB policy rates, were flat at 2.0%.