Euro zone bond yields at week-lows as hurdles eyed to defence spending boost

• Investors weigh uncertain timeline of European defence spending
• Euro zone yields fall while U.S. yields rise, spreads widen
• ECB expected to cut rates next week

Feb 26 (Reuters) - Euro zone government bond yields held near their lowest in over a week on Wednesday, as traders eyed hurdles to an expected increase in European defence spending, much of which is likely to be financed through bond issuance.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, fell 1.5 basis points (bps) to 2.437%, despite a slight rebound in U.S. Treasury yields. It touched 2.432% earlier in the session, its lowest since February 17. Yields move inversely to prices.

Germany's election winner Friedrich Merz on Tuesday ruled out a quick reform to the country's state borrowing limits known as the "debt brake" and said it was too soon to say whether the outgoing parliament could wave through a massive military spending boost.

"Bunds are finding a firmer footing as the market considers a more sober assessment of the near-term implementation and funding impact from defence spending proposals," said Commerzbank analysts in a note.

"The ongoing discussions in Germany show that practical hurdles of the latest proposals to establish another special military fund or a reform of the debt brake over the next month could be higher than the market had initially hoped for."

The U.S. House of Representatives advanced President Donald Trump's tax-cut agenda late on Tuesday, which made U.S. Treasury yields regain some ground.

The spread between 10-year U.S. Treasuries and German Bunds DE10US10=RR widened by 3 bps to 187 bps, after narrowing to its lowest level in about four months on Tuesday.

The risk premium investors demand to hold U.S. rather than German debt has dropped over the past days as traders have factored in emerging concerns about U.S. economic growth, while mulling higher defence spending and borrowing in Europe.

"With evidence that markets have already positioned for stronger defence spending in core European rates and equities, we are mindful of the risk of underdelivery, especially on the timing," said Goldman Sachs analysts.

The U.S. and Ukraine have agreed on the terms of a draft minerals deal central to Kyiv's push to win Washington's support as President Donald Trump seeks to rapidly end the war with Russia, two sources with knowledge of the matter said on Tuesday.

ANTICIPATED ECB CUT

Germany's two-year bond yield DE2YT=RR, which is more sensitive to European Central Bank rate expectations, was little changed at 2.066%.

Markets are pricing in about 82 bps of further ECB policy easing this year, with the central bank widely expected to cut rates for a fifth time in a row next week.

Also in the mix, a survey indicated on Wednesday that German consumer sentiment is set to darken heading into March, as households keep a wary eye on the economic and political situation in Europe's biggest economy.

Italy's 10-year yield IT10YT=RR was 3 bps lower at 3.498%, after falling it its lowest since February 13, narrowing the gap between Italian and German yields DE10IT10=RR to 105.2 bps.