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Traders digest U.S. tariffs

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U.S. pauses military aid to Ukraine

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ECB expected to deliver rate cut this week

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U.S. economy in focus after ISM

(Adds quotes, updates latest prices, adds latest news context)

By Lucy Raitano

LONDON, March 4 (Reuters) - Euro zone bond yields fell

on Tuesday as traders focussed on new U.S. tariffs on Mexico

and Canada, a doubling of duties on Chinese goods, and news that

President Donald Trump had paused military aid to Ukraine.

Germany's 10-year bond yield, the euro zone's

benchmark, fell as much as 6 basis points and was last down 2

basis points (bps) to 2.469%.

The drops were more evident in shorter-dated bonds with

Germany's 2-year bond yield down 5 basis points

(bps) to 2.025%.

Italy's 10-year yield was 2 bps lower at 3.528%

while the 2-year yield was down 5 bps to 2.321%.

Longer-dated yields had risen sharply on Monday, as traders

reacted to the prospect of an increase in government spending on

defence, as European leaders rallied around Ukraine.

On Tuesday, the European Commission floated the possibility

of new joint European Union borrowing to fund an expansion of

defence capabilities - something that will come under discussion

at Thursday's special summit.

"The news flow that we're getting from the U.S. regards to

Ukraine ... is the most important driver for me. There's not

been any confirmation of tariffs on the EU in the same sense as

on Canada and Mexico and China. And of course we have the ECB on

Thursday," Kenneth Broux, head of corporate research, FX and

rates at Societe Generale, said.

Trump paused military aid to Ukraine following his clash

with Ukrainian President Volodymyr Zelenskiy last week and

pressure is growing on European nations to spend more on their

own security, as well as Ukraine's.

"There's a lot of uncertainty and we're trying to square

off German defence spending plans, which we suppose should

result in higher bond yields and higher borrowing, Broux added.

"On the flipside we have the situation on the ground in

Ukraine where there doesn't seem to be any guarantee that the

U.S. will backstop any peacekeeping efforts by European allies,"

he added.

Yields on 30-year German bonds, which on Monday

rose nearly 12 bps, were last up 2 bps at 2.819%.

U.S. Treasury yields edged down on Tuesday,

extending Monday's decline following the latest Institute for

Supply Management manufacturing survey, which showed a sharp

spike in inflation expectations in February, with suppliers

citing tariffs numerous times.

"This morning Bunds are in catch-up mode with the bid in

USTs experienced post close on Monday but with the added spin

that they are bull flattening," RaboBank rates strategists said

in a note, referring to the larger fall in shorter-dated yields

than longer-dated ones.

Broux said the latest ISM survey shows tariffs are already

hurting the U.S. economy.

"If the U.S. economy hits a soft patch in Q1, Europe will

not be unscathed, there will be a downward effect," he said.

Meanwhile, the European Central Bank meets on Thursday and

is expected to deliver a 25-bp rate cut, an expectation

bolstered by latest euro zone figures on Monday that showed

inflation dipped a bit less than expected last month, which also

solidified bets for further policy easing ahead.