Euro area yields struggle for direction as market bets on higher U.S. inflation

(Updates to1137 GMT)

By Medha Singh

Nov 14 (Reuters) -

European government bonds yields struggled for direction on Thursday, while U.S. benchmark Treasury yields climbed to a new multi-month high, as investors geared up for higher U.S. inflation under a new Trump administration. The euro zone benchmark, the German 10-year bond yield , dipped by two basis points at 2.355% after rising for two straight sessions, as traders continued to grapple with the implications of a second Donald Trump presidency.

On the one hand, euro area yields tend to mirror a surge in their U.S. counterparts, and on the other, the threat of U.S. tariffs under the new Trump administration has added to worries about a fragile economic recovery in the euro area, bolstering the case for more rate cuts by the European Central Bank, pressuring yields.

"Europe is really caught in between weakness in European economy, more aggressive ECB easing versus vigilantes in the United States over fiscal policy and trade tariffs," said Kenneth Broux, head of corporate research FX and rates at Societe Generale.

Adding to the mix was political chaos in Germany after the government collapsed last week. With snap elections now slated for February, markets are already pricing in more government spending to aid Europe's largest economy that just dodged a recession.

"Until the election, it's going to be quite erratic," Broux said, about the outlook for euro zone debt markets.

U.S. benchmark 10-year yields hit a four-and-a-half-month high at 4.483%. U.S. President-elect Donald Trump's promises for cutting taxes, raising import tariffs and immigration are seen as widening budget deficits and stoking inflation.

Trump's Republican Party will control both houses of Congress when he takes office in January, Edison Research projected on Wednesday, giving him

more leeway

to push through his policies.

Expectations for inflation over the next decade, measured by the difference between 10-year nominal Treasury yields and yields on 10-year inflation-protected Treasuries, hit 2.122% this week, the highest since early July.

Back in Europe, Germany's 10-year asset swap spread was at -6.1 bps after falling as much as -9.10 bps, its lowest level in at least two decades, according to LSEG data.

Meanwhile, data on Thursday was mixed as a report showed euro zone

industrial production

fell more than expected in September, while another indicated

employment

rose a touch more than expected last quarter and the economy expanded at a respectable pace.

Business surveys due next week will be pivotal in offering more hints about whether the euro zone economy lost momentum in the fourth quarter, Broux said.

ECB Vice-President

Luis de Guindos

said on Thursday the central bank is on its path to cut interest rates further as recent euro zone data show inflation is on track to reach the bank's 2% goal.

Traders are currently fully pricing a quarter-point rate cut by the ECB in December, with about a 20% chance of a 50 bps reduction.

Germany's two-year bond yield, which is more sensitive to ECB rate expectations, was little changed at 2.153% after hitting a near three-week low of 2.097% on Tuesday.

Italy's 10-year yield, the benchmark for the euro zone periphery, fell 3 bps to 3.603%, while the spread between Italian and German 10-year yields - a gauge of risk premium investor demand to hold Italian debt - stood at 121.40 bps, the tightest since October 31.

Investors will look to producer prices data stateside, another inflation gauge, as well as weekly jobless claims at 1330 GMT. (Reporting by Medha Singh in Bengaluru; Editing by Angus MacSwan and Chizu Nomiyama )