March 28 (Reuters) - Money markets increased their bets

on European Central Bank easing, with short-dated yields

dropping to levels last seen before Germany announced its

biggest ever spending package, as investors shifted focus to

U.S. tariffs and weak economic data.

Inflation in March came in far below forecasts in two of the

euro zone's largest economies, while consumer expectations for

price growth remained muted.

Money markets priced in an 80% chance of a 25 basis points

ECB rate cut in April from around 50% a week ago and a depo rate

at 1.9% from around 1.95% late on Thursday.

German 2-year yield, more sensitive to the ECB

policy rates, dropped to 2.028%, its lowest level since March 4.

It was last down 3 bps at 2.04%.

On March 5, German parties reached an agreement for a

massive ramp-up in fiscal spending on infrastructure and defence

investment, leading to the biggest rise in German long-dated

yields in decades.

"It seems likely that the ECB will conclude that the

downside risks from escalating trade tensions are

materialising," said Christoph Rieger, head of rates and credit

research at Commerzbank, referring to the impact of tariffs on

the central bank policy path.

More weak economic data, including inflation and jobs

figures, supported Friday's drop in euro area bond yields.

The number of people out of work in Germany rose in March at

the fastest rate since October of 2024, as Europe's largest

economy is still battling with persistent weakness and

structural headwinds in industry.

Meanwhile, morale among Italian businesses and consumers

slumped in March, as geopolitical tensions and the prospect of

U.S. trade tariffs clouded the outlook.

German consumer sentiment was broadly unchanged, with a

focus on saving highlighting uncertainty among households.

"The confidence boost that German businesses had after the

elections and the fiscal U-turn which followed has not been

entirely embraced by consumers," said Carsten Brzeski, global

head of macro at ING.

"Looking ahead, the gradual weakening of the labour market

looks set to continue," he added.

Italy's 10-year yields dropped 5 bps to 3.83%. The yield gap

between Italian BTPs and German Bunds - a gauge of

risk premium investors ask to hold Italian debt - rose to 110.5

bps.

Citi flagged that "the tightening of BTP-Bund spread, even

as Bund swap spreads richen, might be short-lived due to growth

implications of tariffs and already tight spread levels."

The yield spread between French and German bonds

stood at 69.5 basis points, at the lower end of

its recent range.

Analysts argued that OATs faced a return of political risk

starting next week that might determine whether early elections

are called after July.

Marine Le Pen, leader of France's far-right National Rally

(RN) party, will on Monday learn her fate in an embezzlement

trial that could upend French politics if she is barred from

running in the 2027 presidential election.