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Investors weigh uncertain timeline of European defence

spending

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Euro zone yields fall while U.S. yields rise, spreads

widen

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ECB expected to cut rates next week

(Updates in midday European trade)

By Greta Rosen Fondahn

Feb 26 (Reuters) - Euro zone government bond yields held

near their lowest in over a week on Wednesday, as traders eyed

hurdles to an expected increase in European defence spending,

much of which is likely to be financed through bond issuance.

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

the euro zone bloc, fell 1.5 basis points (bps) to 2.437%,

despite a slight rebound in U.S. Treasury yields. It touched

2.432% earlier in the session, its lowest since February 17.

Yields move inversely to prices.

Germany's election winner Friedrich Merz on Tuesday ruled

out a quick reform to the country's state borrowing limits known

as the "debt brake" and said it was too soon to say whether the

outgoing parliament could wave through a massive military

spending boost.

"Bunds are finding a firmer footing as the market considers

a more sober assessment of the near-term implementation and

funding impact from defence spending proposals," said

Commerzbank analysts in a note.

"The ongoing discussions in Germany show that practical

hurdles of the latest proposals to establish another special

military fund or a reform of the debt brake over the next month

could be higher than the market had initially hoped for."

The U.S. House of Representatives advanced President

Donald Trump's tax-cut agenda late on Tuesday, which made U.S.

Treasury yields regain some ground.

The spread between 10-year U.S. Treasuries and German Bunds

widened by 3 bps to 187 bps, after narrowing to

its lowest level in about four months on Tuesday.

The risk premium investors demand to hold U.S. rather than

German debt has dropped over the past days as traders have

factored in emerging concerns about U.S. economic growth, while

mulling higher defence spending and borrowing in Europe.

"With evidence that markets have already positioned for

stronger defence spending in core European rates and equities,

we are mindful of the risk of underdelivery, especially on the

timing," said Goldman Sachs analysts.

The U.S. and Ukraine have agreed on the terms of a draft

minerals deal central to Kyiv's push to win Washington's support

as President Donald Trump seeks to rapidly end the war with

Russia, two sources with knowledge of the matter said on

Tuesday.

ANTICIPATED ECB CUT

Germany's two-year bond yield, which is more

sensitive to European Central Bank rate expectations, was little

changed at 2.066%.

Markets are pricing in about 82 bps of further ECB policy

easing this year, with the central bank widely expected to cut

rates for a fifth time in a row next week.

Also in the mix, a survey indicated on Wednesday that German

consumer sentiment is set to darken heading into March, as

households keep a wary eye on the economic and political

situation in Europe's biggest economy.

Italy's 10-year yield was 3 bps lower at 3.498%,

after falling it its lowest since February 13, narrowing the gap

between Italian and German yields to 105.2 bps.