Euro zone yields chase Treasuries lower; one eye on Trump

(Updates with European afternoon trading, US inflation data)

By Stefano Rebaudo

Dec 20 (Reuters) - Euro zone government bond yields fell on Friday, echoing a retreat in Treasury yields after U.S. data showed consumer inflation cooled in November, softening the case for the Federal Reserve to keep rates higher for longer.

European markets had been set on edge earlier in the day, after President-elect Donald Trump warned the European Union to buy more U.S. oil and gas or face hefty tariffs.

The U.S. personal consumption expenditures index (PCE) excluding food and energy prices rose 2.8% in November on an annual basis, matching October's rise and below forecasts for a rise of 2.9%.

Even though U.S. data has little direct bearing on euro zone monetary policy, the yield on 10-year German Bunds, the benchmark for the region, fell 3 basis points to 2.278%, tracking a steeper 6.4-bp drop in 10-year Treasury yields

The premium that Bunds command over Treasuries, which hit its largest in more than five years on Thursday, subsided to around 222 bps, down around 3.7 bps on the day, while Bunds were on track for their third straight weekly rise.

"All the macro data this morning was cooler than expected. This is good news for markets, but it doesn't change the path for the Fed," Peter Cardillo, chief market economist at Spartan Capital Securities, said.

Investors are preparing for U.S. interest rates to take longer to fall in 2025, after the Federal Reserve on Wednesday indicated that further interest rate cuts would depend on how quickly inflation subsides.

"A return to hikes is a low probability event, but the Fed will want to see further progress on inflation or an increase in the unemployment rate before resuming the easing cycle," said Tiffany Wilding, economist at PIMCO.

"The Fed believes the current rate, at 4.3% and change, is still restrictive and therefore maintained a cutting bias."

Markets are pricing in just 40.6 bps of rate cuts in the U.S. by the end of 2025, which implies one 25-bp move and around a roughly 50% chance of a second cut in that time, from around 50 bps right before the Fed statement.

In contrast, the swaps market shows traders expect the European Central Bank to lower its benchmark rate to around 1.82% by July, equal to around 120 bps in cuts.

Adding more uncertainty to the fixed income markets was the risk of a U.S. government shutdown this weekend, following one in December 2018 into January 2019 during Trump's first term in the White House.

German two-year yields were down 3.7 bps at 2.02%, heading for a weekly drop of nearly 4 bps.

French politics remained in the spotlight, with investors trying to assess whether a new government can tackle France's fiscal problems.

The yield spread between French government bonds and safe-haven Bunds - a gauge of the premium investors demand to hold French debt - was at 80 bps. It recently hit 90 bps, its highest in over 12 years.

The French Senate approved on Wednesday a special law designed to prevent any interruption of public services, by rolling over 2024 budget rules.

France's new prime minister, Francois Bayrou, said on Thursday he hoped to have a budget ready by mid-February. (Additional reporting by Amanda Cooper in London; Editing by Hugh Lawson and Alex Richardson)