Jan 6 (Reuters) - Euro zone benchmark Bund yields hit a

fresh two-month high on Monday, with markets scaling back bets

on European Central Bank rate cuts ahead of the release of

German inflation data.

The consumer price index of the German state of Hesse rose

2.7% year-on-year. National data will be released later in the

session.

Euro area borrowing costs increased on Friday after data

showed German unemployment rose less than expected in December.

Germany's 10-year government bond yield was up 2

basis points (bps) to 2.44% after hitting 2.457%, its highest

level since Nov. 7.

A stronger economy could lead the European Central Bank to

be more cautious when it comes to interest rate cuts.

Germany's 2-year yield, which is more sensitive

to expectations for ECB rates, rose 1.5 bps to 2.18%, after

reaching 2.213%, its highest since Nov. 8.

The euro zone labour market's exceptional resilience is

unlikely to last, although there is also no dramatic weakening

on the horizon, ECB research showed on Monday.

Markets priced in an ECB deposit facility rate at 2.1% in

July 2025. This compares with 2.05% late on Friday and 1.9%

before Christmas. The depo rate is

currently at 3%.

Analysts flagged that ECB policymaker Yannis Stournaras, one

of the more dovish council members, said last week he expected

the bank's main interest rate to be cut to 2% by the autumn.

Government bond supply is also in the spotlight, with Citi

forecasting gross issuance from the first 11 countries which

adopted the euro (EMU-11) in 2025 to be 45 billion below the

record high seen in 2024.

"The decrease in supply is largely driven by Germany, Italy

and Spain, while France, net of buybacks, and Portugal should

see an increase," said Puja V Sawant, strategist at Citi.

The closely watched gap between French and German bond

yields - a gauge of the premium investors demand to hold French

debt - was at 83.5 bps.

It jumped to around 90 bps in the summer as elections

plunged France into political turmoil and raised fears that it

could struggle to curb a burgeoning public deficit.

France failed to approve a budget for 2025 before an

end-of-year deadline, and President Emanuel Macron had to name

his fourth prime minister of 2024 in December.

Finance Minister Eric Lombard said on Monday that the 2025

budget bill targeted 50 billion euros in cost savings - a lower

figure compared to those targeted by the previous government.

Italy's 10-year yield dropped one bp to 3.59%,

after hitting 3.61%, its highest since Nov. 21. The gap between

Italian and German yields tightened to 114 bps.