Bund yields edge up, spreads widen after Israel attacks Iran

By Stefano Rebaudo

June 13 (Reuters) - Euro zone benchmark Bund yields edged up on Friday after briefly hitting three-month lows, as a rush into safe-haven government bonds following Israel's wide-scale strikes against Iran faded.

Euro area borrowing costs reversed an earlier drop as the policy rate outlook remained stable, with markets pricing a European Central Bank deposit facility rate at 1.75% in December EURESTECBM4X5=ICAP at levels seen since after the last ECB policy meeting last week.

They ticked up after U.S. President Donald Trump urged Iran to make a deal over its nuclear programme, saying that there was still time for to prevent further conflict with Israel.

"These events typically affect equities and oil prices more directly," said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

Oil prices jumped more than 7% on Friday, trading near multi-month highs.

"Government bond markets tend to be less affected unless monetary policy expectations change," he added.

German 10-year Bund yields DE10YT=RR rose 1.5 basis points (bps) to 2.49%, having marked a session low of 2.422%, the lowest since March 3. Yields on the two-year Schatz DE2YT=RR rose 2 bps to 1.83%.

Bund yields also recorded their largest weekly decrease since late March, with a decline of 8 bps.

Money markets priced in around a 60% chance of an ECB easing move in September EURESTECBM2X3=ICAP, while fully pricing such a move by December.

ECB Executive Board Member Isabel Schnabel said on Thursday that interest rates are in a "good place", despite an expected slowing of inflation, because price growth is likely to return to the ECB's target of 2% over the medium term.

Analysts argued that with rates at a neutral level, a pause of the easing cycle looks very likely, although some officials do not want to take another cut off the table.

The euro zone's economy has proven resilient but faces several risks, such as tariffs, that could curb growth, ECB Vice-President Luis de Guindos said on Thursday.

Longer-dated 30-year German debt DE30YT=RR was up one bp at 2.97%, after hitting 2.898%, its lowest since May 2.

A drop in appetite for risk assets widened yield spreads for government bonds of highly indebted countries, such as Italy and France, against the safe-haven Bunds.

Investors argued that the Italian spread — the benchmark for the euro area's non-core countries — moves in line with risk assets unless there is a very specific Italy-related driver.

Italian spread DE10IT10=RR widened to 94 bps after hitting 84.20 bps early this week, its tightest since March 2015. Italy's 10-year yields IT10YT=RR were up 4 bps at 3.46%.

The French spread DE10FR10=RR rose more sharply, hitting 73.90 on Friday, its highest level since April 24.

The gap between Italy and France IT10YT=RR, FR10YT=RR dropped to below 25 bps, its tightest level since 2008.