Euro zone bond yields higher as strong U.S. data dents large rate cut hopes

(Updates at 1008 GMT)

By Samuel Indyk

LONDON, Oct 7 (Reuters) - Euro zone government bond yields rose on Monday, adding to a sharp jump at the end of last week following stronger-than-forecast U.S. labour market data that markets think will allow the Federal Reserve to slow its pace of easing.

Germany's 10-year yield, the euro area benchmark, was up 3 basis points (bps) at 2.242%, after touching its highest level in a month at 2.258%.

The U.S. added 254,000 nonfarm payrolls in September, well above expectations in a Reuters survey of economists. The unemployment rate dropped to 4.1%.

"The payroll report should put to rest any expectations of a 50bp cut in November," said Mohit Kumar, an economist at Jefferies.

Futures markets almost fully wiped out the chances of another 50 bp rate cut from the Fed at the meeting next month - which stood at around a one-in-three chance before the data - with markets seeing a 25 bp rate cut as the most likely outcome.

US Treasury yields jumped. The benchmark 10-year yield rose to 4% for the first time in two months, while the two-year yield rose 6 bps on Monday, adding to Friday's 21 bp rise.

The size and importance of the U.S. economy means U.S. economic data tends to impact bond markets globally.

The European Central Bank is still widely expected to lower interest rates when it meets next week, with markets fully pricing in a 25 bp move.

"Monetary policy within the euro area is still restrictive and there is room to recalibrate policy closer to the neutral level," said Robert Bergqvist, senior economist at SEB.

"I think central banks should move with a normal step and that implies a 25 basis point move next week."

ECB policymaker Francois Villeroy de Galhau said the central bank will

probably cut interest rates

in October as growth is weak, raising the risk that inflation will undershoot the 2% target.

Growth indicators continue to point to a stuttering economy.

Business activity

in the bloc contracted last month for the first time since February, a survey showed last week.

German industrial orders

fell by 5.8% in August, data showed on Monday.

"You have downside risks to growth, especially when you look at the manufacturing industry and you look at Germany," SEB's Bergqvist said.

Germany's two-year yield, which is sensitive to changes in monetary policy expectations, was up 4 bps at 2.248%. It jumped over 13 bps on Friday, its biggest one-day rise since April, 2023.

Italy's 10-year yield was up 3 bps at 3.55%, with the gap between Italian and German 10-year yields steady at 130 bps.

Sovereign bond issuance from the euro zone is expected to decline this week, with Italy, Germany, Austria and the Netherlands set to come to market.

UniCredit strategist Francesco Maria Di Bella expects the issuance to amount to 15 billion euros, down from 26 billion euros last week. (Reporting by Samuel Indyk, editing by Ed Osmond)