Euro zone yields rise on U.S.-Russia talks and hawkish ECB comments

Updates prices, adds chart, background

By Harry Robertson and Stefano Rebaudo

LONDON, Feb 19 (Reuters) - Euro zone government bond yields rose to their highest in more than two weeks on Wednesday as investors focused on potential extra borrowing amid U.S.-Russia talks on Ukraine and comments from a European Central Bank official floating a pause to rate cuts.

Germany's 10-year yield DE10YT=RR, the benchmark for the euro zone bloc, rose 4 basis points (bps) to 2.17% after hitting 2.19%, the highest since January 30. Yields rise as prices fall and vice versa.

Benchmark German yields have risen around 12 bps this week after U.S. President Donald Trump initiated talks with Russia over ending the Ukraine war, and figures in his administration said Europe will have to shoulder more of the security burden.

That implies higher spending on defence and so higher borrowing via bond markets, adding to upward pressure on yields.

The European Commission will propose exempting defence from EU limits on government spending, EC President Ursula von der Leyen said on Friday.

"Not only politicians but also markets seem to be waking up to the reality that there will be substantially more defence spending, and that will have to be financed somehow," said Jussi Hiljanen, head of European rates strategy at SEB.

Any potential resolution of the conflict in Ukraine would likely strengthen the European economy by helping to reduce gas prices and ease inflationary pressures.

Investors were also digesting the latest tariff threats from U.S. President Donald Trump, who said he intends to put a roughly 25% levy on cars. Elsewhere, UK inflation came in higher than expected, rising to 3% in January from 2.5% in December.

ECB JOLT

Yields rose after ECB Governing Council member Isabel Schnabel told the Financial Times in an interview published on Wednesday that the central bank should start a discussion about whether further rate cuts are necessary.

Germany's two-year bond yield DE2YT=RR, which is sensitive to ECB rate bets, rose and was last up 4 bps at 2.17%.

Money market traders knocked about 4 bps off their bets on further rate reductions and were last predicting around 72 bps of cuts by the end of December. EURESTECBM7X8=ICAP

Italy's 10-year yield IT10YT=RR was last up 8.5 bps at 3.63%, set for its biggest one-day rise since mid-December. Countries such as Italy with higher debt levels tend to benefit the most from reduced borrowing costs.

The yield spread between Italian bonds and German Bunds DE10IT10=RR widened to 108 bps, after narrowing to just above 100 basis points earlier in the session - close to levels not seen since September 2021.

The spread between French and German 10-year bond yields widened by around 2 bps to 68 bps, after hitting 65.80 bps on Tuesday, its lowest since July DE10FR10=RR. The eventual passing of a budget earlier this month has cooled investors' concerns about France's public deficit outlook.

Italian and French spreads dropped as investors bet on more issuance of joint European Union debt to fund military spending.