Euro zone bond yields steady amid US-EU tariff negotiations

By Stefano Rebaudo

May 26 (Reuters) - Euro zone government bond yields were little changed on Monday as the U.S. backed away from its threat to slap 50% tariffs on European imports, easing fears of a sharp economic slowdown.

U.S. President Donald Trump restored a July 9 deadline to allow negotiations, with a European Commission spokesperson saying a phone call between European Commission President Ursula von der Leyen and Trump had given trade talks a new impetus.

Trump's reversal drove stocks and the euro higher in the session, but analysts said the latest developments highlighted that Washington has not turned the page on its erratic tariff negotiation tactics, and more trade policy volatility lies ahead.

ECB President Christine Lagarde said at a lecture in Berlin that the euro could become a viable alternative to the dollar, if governments could only strengthen the bloc's financial and security architecture. The ECB is expected to cut interest rates by 25 basis points next week.

Germany's 10-year yield DE10YT=RR slid 1.5 bps to 2.56%, after rising modestly earlier in the session. It had dropped 6.5 bps on Friday.

Trading volumes on Monday were likely thinner than usual as markets in the U.S. and Britain are closed due to public holidays.

U.S. Treasury yields dropped on Friday as Trump's remarks raised concerns about slowing economic growth, but market participants fear that concerns about a growing fiscal deficit will keep borrowing costs at high levels.

"With the passage of the tax bill through the House, the focus is now on the changes as it makes its way through the Senate to alleviate the market concerns around the fiscal trajectory," ING strategists said in a research note.

Money markets priced in an ECB deposit facility rate at 1.68% by year-end EURESTECBM5X6=ICAP, up from 1.67% late Friday. The pricing reached 1.55% after the ECB suggested in mid-April it could cut rates in response to a possible tariff-induced economic slowdown.

Money markets also effectively fully priced in a rate cut in June, while indicating a 31% chance of another drop in July.

German 2-year government bond yields DE2YT=RR, more sensitive to ECB policy rates, were up 3 bps at 1.79% after falling 7 bps on Friday.

Italy's 10-year yield was down 4 bps at 3.57% IT10YT=RR in afternoon trading, after Moody's on Friday upgraded the country's credit rating outlook to "positive".

The spread between Italian and German yields – a market gauge of the risk premium investors demand to hold Italian debt – stood at 98 bps DE10IT10=RR. It hit 90.90 bps last week, its lowest since February 2021.