Euro zone yields drop to multi-week lows, await ECB neutral rate estimate

By Stefano Rebaudo

Feb 5 (Reuters) - Euro area government bond yields dropped to multi-week lows on Wednesday as investors feared a possible disinflationary impact of U.S. tariffs, which could lead the European Central Bank to deepen its easing path.

Investors also await updated estimates of the so-called neutral rate (r*) that the ECB staff will publish on Friday.

Ris the interest rate level that keeps the economy in balance, with full employment and stable inflation, and is usually the rate target for central banks.

"Friday's revision could conclude a tighter range with a higher minimum," Citi said, recalling that in Davos, ECB President Christine Lagarde had indicated 2.25% and 1.75%.

Money markets priced in an ECB deposit facility rate at 1.85% in December EURESTECBM7X8=ICAP from 1.95% late Friday before the tariff announcements by U.S. President Donald Trump.

Some analysts argued that the demand shock facing euro zone exporters in case of higher U.S. import duties was likely more significant than the inflationary effect of potential European Union retaliatory tariffs.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, fell 4 basis points (bps) to 2.351%, its lowest level since Jan. 2.

German two-year yields DE2YT=RR, more sensitive to European Central Bank rate expectations, were down 3 bps at 2.03%. It hit 2.01% on Monday, its lowest since Dec. 20.

The ECB is confident that inflation will approach 2% this year, but there are still uncertainties, particularly surrounding the geopolitical situation, the bank's vice president, Luis de Guindos, said in an interview.

Economists said investors were not taking Trump's comments about the U.S. taking over Gaza seriously, but flagged that a move of that kind would heighten tensions in the Middle East, boosting oil prices.

The yield spread between French OATs and German Bunds DE10FR10=RR - a market gauge of the risk premium investors demand to hold French debt - was at 71 after hitting 69.90 bps on Tuesday, its tightest level since Oct. 31.

It widened to around 90 bps, its highest since 2012, in mid-January and end-November amid fears that France would be unable to cut its growing budget deficit.

French far-right leader Jordan Bardella suggested on Tuesday his party would likely not back no-confidence motions against Francois Bayrou's minority government, which rammed the 2025 budget bill through parliament on Monday.

"An ongoing OAT recovery should be used to add to structural shorts in the semi-core complex against Iberia and European Union (bonds)," said Michael Leister, analyst at Commerzbank.

Semi-core euro area bonds include those from France, Belgium and the Netherlands.

Italy's 10-year yield IT10YT=RR dropped 4.5 bps to 3.45%, its lowest since Dec. 20. The gap between Italian and German yields DE10IT10=RR stood at 109 bps.