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German yield curve flattens after recent steepening

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Markets shrug off elections in Japan

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US-EU trade negotiations in focus

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HSBC sees no further ECB rate cuts if tariffs around 10%

(Updates with afternoon pricing)

By Stefano Rebaudo

July 21 (Reuters) - Benchmark German bond yields headed

for their biggest one-day drop since early April on Monday as

investors snapped up longer dated debt ahead of euro zone PMI

surveys and the European Central Bank's monetary policy decision

later this week.

The drop in 10-year yields outpaced that in shorter-dated

bonds, a dynamic known as yield curve flattening, following four

weeks of steepening trades, where investors focussed on

Germany's plans to increase government spending and the likely

impact on long-term borrowing costs.

Markets forecast that increased fiscal spending will lead to

a greater supply of government bonds, and higher yields.

Economists expect the ECB to leave rates unchanged on

Thursday, before potentially cutting them in September.

Germany's 10-year government bond yield, the

euro area's benchmark, fell as much as 8.2 basis points at one

point, and was last down 7.5 bps at 2.61%.

Some analysts expect June PMIs on Thursday to show business

activity stagnated, citing tariff uncertainties and a strong

euro - factors that could lend support to Bund prices.

German two-year government bond yields - which

are more sensitive to changes in expectations for ECB policy -

fell 4.2 bps to 1.811%, leaving the premium of 10-year debt over

2-year at 80.5 bps, down 3.8 bps on the day.

Money markets are fully pricing in one 25-bp ECB rate cut by

December, and around a 50% chance of that

move coming in September.

Investors are also watching tariff negotiations after the

Financial Times reported on Friday that U.S. President Donald

Trump is pushing for a minimum tariff of 15% to 20% in any deal

with the European Union.

"I believe June marked the final (ECB) rate cut, assuming

the average U.S. tariffs for Europe will be at around 10%," said

Simon Wells, chief European economist at HSBC.

"A persistent 30% tariff might not be enough to trigger a

recession but, in this case, we will likely see some ECB

reaction," he added.

Euro zone firms remain optimistic about their growth

prospects but are also experiencing pressure on their profits,

in part due to trade tensions, an ECB survey showed on Monday.

Italy's 10-year government bond yields were down

9.5 bps at 3.483%, with the spread between BTP and Bund yields -

a market gauge of the risk premium investors demand to hold

Italian debt - at 86.4 bps. It hit 84.20 bps in June, its lowest

since March 2015.