Bund yields hit fresh 17-month high as Merz seeks deal to boost spending

By Stefano Rebaudo and Lucy Raitano

March 12 (Reuters) - Bund yields rose to a fresh 17-month high on Wednesday before moderating, as Germany's likely next chancellor worked to secure support for a massive increase in state borrowing aimed at revamping the economy and boosting military spending.

The clock is ticking for Friedrich Merz to persuade lawmakers in the outgoing parliament while a co-leader of the Greens was non-committal about whether a deal could be done.

Germany's 10-year government bond yields DE10YT=RR were up 2 basis points (bps) at 2.892%, having earlier risen as much as 7 bps to the highest since October 2023. They jumped 44.7 bps last week in their biggest rise since February 1990.

Euro zone bonds showed little reaction to U.S. consumer price data that showed inflation increased moderately in February, giving the Federal Reserve room to hold interest rates next week while monitoring the economic impact of a trade war.

Investors appeared to set aside concerns that U.S. tariffs could weaken the economy and prompt the European Central Bank to ease monetary policy, driving borrowing costs lower.

President Donald Trump's 25% tariffs on U.S. steel and aluminium imports took effect on Wednesday.

Citi analysts suggested that if the German fiscal re-pricing moved to the background, shorter-term drivers - such as growth risks from tariffs and global uncertainty - could drive Bund yields into a 2.25-2.75% range.

Traders priced in an ECB deposit facility rate of 2.07% in December EURESTECBM6X7=ICAP from 1.92% last week before the announcement of German fiscal plans, and around a 50% chance of a 25 bp rate cut in April.

The spread between the 10-year overnight index swap EUREON10Y= - regarded as a risk free rate - and Bund yields was at -20 bps after hitting -29 bps last week, its lowest level since 2010, during the aftermath of the Global Financial Crisis.

"Despite ongoing turbulence, it is possibly too early to call the end of the Bund's safe-haven status," said Jamie Searle, European rate strategist at Citi.

Investors suggested the euro zone safe-haven benchmark might be nearing a tipping point in the asset swap market.

Peace talks remained in focus after Ukraine said it was ready to support Washington's proposal for a 30-day ceasefire with Russia, amid scepticism from Moscow.

Germany's 2-year yield DE2YT=RR, more sensitive to ECB policy rates, was up 3 bps at 2.233%.

The yield gap between Italian and German bonds DE10IT10=RR - a market gauge of the risk premium investors demand to hold Italian debt - was at 105 bps after dropping below 100 bps for the first time since 2021 last week.