Jan 31 (Reuters) - Euro zone short-dated government bond

yields were on track to record their biggest weekly drop in

months, after a raft of weak economic data led traders to ramp

up their bets on future rate cuts from the European Central

Bank.

Borrowing costs inched higher early on Friday, after falling

the day before, when the ECB's policy decision barely moved

expectations for the outlook for interest rates.

Germany's rate-sensitive two-year bond yield, was

down 81 basis points (bps) at 2.18% on Friday. It was set to end

the week 16 bps lower in its biggest fall since the week of

Sept. 23.

"The ECB will likely want to provide further support to the

weak euro zone economy. German data from today - soft retail

sales while the unemployment rate is edging up - also fit this

view," said Salomon Fiedler, economist at Berenberg.

Money markets priced in an ECB deposit facility rate at

1.95% at the end of 2025 - which implies

three 25-bp cuts and a 20% chance of a fourth by year-end -,

from over 2.1% early this week.

Germany's core inflation eased markedly, while the

unemployment rate rose as the weakness of Europe's biggest

economy took its toll on the labour market.

French consumer prices increased slightly less than

anticipated to 1.8% year on year.

"We expect overall inflation in France to remain close to

the current level on average over 2025 before returning to close

to 2% in 2026," said Charlotte de Montpellier, senior economist,

France and Switzerland at ING.

Data showed on Thursday the economy contracted spurring

recession fears in Germany, while Italy stagnated and French

growth retreated slightly.

Germany's 10-year government bond yield, the

euro area's benchmark, fell 6 bps to 2.457%, and was about to

end the week 6 bps lower.

However, euro zone consumers and economists increased their

inflation expectation for this year, surveys showed on Friday.

U.S. Treasury yields edged up with the 10-year

rising one bp to 4.52%, as data showed U.S. prices increased in

December while consumer spending surged.

The yield spread between OATs and Bunds - a

market gauge of the risk premium investors demand to hold

Italian debt - tightened to 74 bps, after French Finance

Minister Eric Lombard said on Friday that talks on getting the

2025 budget passed through parliament were "on the right track".

It widened to around 90 bps, its highest since 2012, in

mid-January and end-November amid fears that France would be

unable to cut its growing budget deficit.

Italy's 2-year government bond yield posted its

biggest fall since mid-October, 8 bps lower to 2.44%.

The gap between Italian and German 10-year yields

was at 109.1 bps, not far from its lowest level

since October 2021 at 104.50 bps.