Germany's two-year yields drop on fears ECB is behind the curve

By Stefano Rebaudo

Oct 23 (Reuters) - Germany's two-year government bond yields fell on Wednesday, and money markets increased their bets on a 50 basis point European Central Bank rate cut in December, as investors expect the bank to accelerate its monetary easing cycle.

The ECB could undershoot its inflation target and be at risk of acting too late in unwinding past rate hikes, French central bank chief Francois Villeroy de Galhau said on Tuesday.

ECB policymakers have begun to debate whether interest rates need to be lowered enough to start stimulating the economy, half a dozen sources indicate.

Markets are now discounting an ECB deposit facility rate at around 2% in June 2025, compared with 3.5% currently. They have also fully priced a 25 basis point (bps) rate cut in December and around a 40% chance of a 50 bps move, from around 25% the day before.

Germany's two-year bond yield, which is more sensitive to ECB rate expectations, dropped 6 bps to 2.14%. It hit 2.218%, its highest since Oct. 15, on Tuesday.

Germany's 10-year bond yield, the benchmark for the euro zone, fell one bp to 2.31%. It reached 2.334% on Tuesday, its highest since Sept. 3, after rising more than 13 bps in two sessions.

The gap between French and German 10-year yields - a gauge of the risk premium investors demand to hold France's government bonds - was last at 73 bps. It was around 75 bps before Prime Minister Michel Barnier presented the budget bill for 2025. Markets await Moody's rating review late on Friday.

Italy's 10-year yield was 0.5 bps lower at 3.55%, and the gap between Italian and German yields at 123 bps, after hitting 116 bps on Monday, its lowest level since June. (Reporting by Stefano Rebaudo; Editing by Mark Potter)