Euro area yields drop as markets price in Iran-Israel ceasefire to hold

By Stefano Rebaudo

June 25 (Reuters) - Euro area government bond yields dropped on Wednesday as markets priced in expectations that the Iran-Israel ceasefire would hold, while shifting their focus to macroeconomic data and the fiscal plans of euro area countries.

German cabinet's approved a draft budget with record investments on Tuesday.

Meanwhile, NATO leaders gathered in The Hague with European allies hoping a pledge to hike defence spending will dispel U.S. President Donald Trump's doubts about his commitment to the alliance.

German 10-year government bond yields DE10YT=RR, which serve as the benchmark for the wider euro zone, fell 2 basis points (bps) to 2.52%.

Yields on 30-year German bonds DE30YT=RR were down 1.5 bps after climbing 5 bps on Tuesday.

Analysts expect rising bond supply across the euro area due to more fiscal spending to drive long-term yield higher.

Spanish Economy Minister Carlos Cuerpo said his country does not expect any repercussions from its refusal to meet the defence spending target of 5% of gross domestic product.

"In terms of economic effects what matters is not only the scale of European spending, but also the extent to which dependence on U.S. procurement is reduced," said Paul Donovan, chief economist at UBS Global Wealth Management, referring to the NATO summit.

Closely watched oil prices held near multi-week lows on the prospect that crude flows would not be disrupted, after a ceasefire between Iran and Israel.

"Financial markets have priced in an Iran-Israel ceasefire holding," UBS GWM's Donovan argued. "That skews the risks if there is any further military activity."

Analysts argued that a spike in energy prices could have disrupted the current narrative of disinflationary pressures in the euro area and the U.S., leading markets to scale back their bets on central bank rate cuts.

Money markets priced in a European Central Bank deposit facility rate at 1.75% in December EURESTECBM4X5=ICAP, levels seen before the Israeli attack against Iran on June 13, after a rise up to 1.80% on Monday.

A key market gauge of euro area long-term inflation expectations EUIL5YF5Y=R was at 2.12% on Tuesday from around 2.08% on June 12.

Italy's 10-year yields dropped 2 bps to 3.46%. The Italian yield gap versus Bunds DE10IT10=RR — a market gauge of the risk premium investors demand to hold Italian debt — was at 95 bps, after tightening 5 bps the previous day.