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German yields drop on tariff worries

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ECB could lower rates to boost growth

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Some analysts expect Fed will not ease policy this year

(Recasts after Reuters report on U.S. tariffs)

By Stefano Rebaudo

Feb 7 (Reuters) - Euro zone government bond yields

recorded their second straight weekly fall over concerns that

potential U.S. tariffs could deliver a deflationary shock to the

European economy.

German borrowing costs increased on Friday after U.S. data,

but later erased their rise after three sources familiar with

the plans told Reuters that President Donald Trump had told

Republican lawmakers that he intends to announce reciprocal

tariffs.

U.S. figures released earlier in the day showed January job

growth had slowed more than expected, following strong gains in

the previous two months. However, the unemployment rate was at

4%, while hourly earnings showed significant increases.

Markets increased bets on future European Central Bank rate

cuts after the Reuters report on U.S. tariffs. They priced an

ECB deposit facility rate at 1.87% in December 2025

, from 1.93% after the U.S. data. They had

discounted a depo rate at 1.85% early this week after Trump

announced tariffs against China, Canada and Mexico.

Germany's 10-year bond yield, the benchmark for

the euro zone bloc, was roughly unchanged at 2.38%. It was set

to end the week 8.3 bps lower after falling 8.5 bps the week

before on weak economic data.

While markets price in 37 bps of Federal Reserve rate cuts

in 2025, which implies one 25 bps easing move and a 48%

chance of a second one, some analysts believe the Fed will not

ease policy this year.

"With economic growth above trend and Trump policies adding

to inflation risks, we see no reason for the Fed to cut rates

further," Atakan Bakiskan, U.S. economist at Berenberg, said.

NEUTRAL RATE

Markets still fear Trump will impose import duties against

the European Union, and analysts have said the demand shock

facing euro zone exporters would be likely more significant than

the inflationary effect of potential EU retaliatory tariffs.

The euro area neutral level for the deposit rate, which

neither stimulates nor restricts growth, is seen at between

1.75% and 2.25%, the ECB said earlier in the session.

The ECB should stand ready to ease borrowing costs to a

level lower than neutral to boost growth, ECB policymakers Olli

Rehn and Mario Centeno said this week.

German two-year yields, more sensitive to ECB

rate expectations, dropped 1 bp to 2.05%.

The yield spread between OATs and Bunds - a

market gauge of the risk premium investors demand to hold French

debt - was at 72 bps, after the French Senate on Thursday

approved the 2025 budget.

"We are at the bottom of the range of the past six months,

so if there's volatility, the spread could widen," said Eliezer

Ben Zimra, fixed income fund manager at Carmignac.

"Even if we have more government stability, we don't have

any structural reform to reduce debt," he added, flagging that

the yield gap could fluctuate between 70 and 100 bps.

The yield gap hit 69.60 bps on Wednesday, its tightest level

since October 31. 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 10-year yield was 2 bps higher at 3.47%,

and the gap between Italian and German yields

stood at 109 bps.