Euro zone bond yields edge down; traders mull potential German defence fund

Updates in late European trade

By Lucy Raitano and Greta Rosen Fondahn

LONDON, Feb 25 (Reuters) - Euro zone bond yields edged lower on Tuesday, though not by as much as U.S. yields, while markets weighed signs that Germany could approve a boost in defence spending before the outgoing parliament quits, a move likely to require more borrowing.

Traders considered a report that Germany is discussing 200 billion euros ($209.78 billion) for an emergency defence fund as the country digests its election result.

Remarks from U.S. President Donald Trump overnight that his planned tariffs on Canadian and Mexican imports are on track to come into force at the start of March also kept traders on edge.

Germany's 10-year Bund yield DE10YT=RR - a benchmark for the wider euro area - was down one basis point (bp) at 2.457%. Yields move inversely to prices.

Meanwhile benchmark 10-year U.S. Treasury US10YT=RR yields fell 9 bps to 4.306%, while data added to emerging concerns about U.S. economic growth.

"Bund yields are holding up ... diverging from the U.S. This could be related to Germany's plan to fast-track defence spending and positioning for 10-year supply tomorrow," said Kenneth Broux, head of corporate research, FX and Rates at Societe Generale.

The risk premium investors demand to hold U.S. debt rather than German Bunds DE10US10=RR in turn dropped to its lowest level since November.

Italy's 10-year yield IT10YT=RR was down 3 bps at 3.531%. The yield gap between Italian and German government bonds DE10IT10=RR was 106.8 bps.

ECB SPEAKERS

Germany's 2-year bond yield DE2YT=RR, which is more sensitive to European Central Bank policy rates, fell for a fourth day. It was last down 2 bps at 2.068%.

Traders have increased their bets for ECB cuts and now expect a further 83 bps of easing this year, compared to about 71 bps last Wednesday.

Investors on Tuesday scrutinised remarks from ECB policymakers, ahead of the central bank's monetary policy meeting next week, where it is widely expected to cut rates for the fifth time in a row.

The ECB has room to cut interest rates further if inflation eases to its 2% goal this year as it expects, ECB policymaker Joachim Nagel said on Tuesday, adding that the outlook for prices was "encouraging".

Meanwhile, ECB board member Isabel Schnabel said it was no longer clear that the central bank's 2.75% deposit rate was still holding back the economy.

Also in the mix, the German economy, Europe's largest, shrank by 0.2% in the final quarter of 2024 compared with the previous quarter, the statistics office reported on Tuesday, confirming a preliminary reading.

($1 = 0.9534 euros)