Euro zone bond yields fall as US tariffs loom, markets mull ECB rate outlook

(Updates prices, adds quotes, context)

By Lucy Raitano

LONDON, April 1 (Reuters) - Euro zone bond yields fell on Tuesday, as traders awaited details of U.S. President Donald Trump's reciprocal tariffs on Wednesday while the latest inflation figures backed the market's expectation of a European Central Bank rate cut in April.

Germany's 10-year bond yield, the benchmark for the euro zone bloc, fell 5 basis points to 2.679%, but stayed off a month low of 2.659% hit on Monday.

Italy's 10-year yield meanwhile hit its lowest level since March 5, slipping 8 bps to 3.785%.

The gap between Italian and German yields narrowed 3.1 bps to 110.5 bps.

Germany's interest-rate sensitive two-year bond yield was down 1 bp at 2.016%, while short-dated Italian bonds were 3 bps lower at 2.285%.

Traders are bracing for Wednesday when Trump's reciprocal tariffs are expected to come into effect.

EU executive chief Ursula von der Leyen said on Tuesday the European Union had a "strong plan" to retaliate against tariffs imposed and which are set to be imposed by Trump, although it would prefer to negotiate a solution.

Traders were also mulling the ECB's next move at its April 16-17 meeting, with markets still placing high bets of 80% on the chance of a 25 bps cut.

On Wednesday, Finnish central bank governor Olli Rehn told media company Politico that the ECB should cut interest rates in April if inflation keeps moving in line with its projection and more easing would keep price growth on track.

Data on Tuesday showed euro zone inflation eased as expected last month and a key measure of underlying price pressures also fell, likely adding to widespread expectations for another ECB interest rate cut later in April.

Final purchasing managers index surveys were also released, showing output rising for the first time in two years in the region's manufacturing industry.

Eurostat data on Tuesday showed unemployment falling to an all-time low of 6.1% in February.

"When you look at some of the other data, like the unemployment data... from that point of view you would be expecting a slightly different market reaction, so that's what leads me to the conclusion that it's probably the tariff story that is overpowering everything," said Peter Schaffrik, global macro strategist at RBC Capital Markets.

Key U.S. data reads will come later in the day, but are also unlikely to move the dial on markets.

"No one's going be paying much attention to data today unless US JOLTS and ISM surprise .. market set up is defensive into tomorrow," said Kenneth Broux, head of corporate research FX and rates at Societe Generale. (Reporting by Lucy Raitano; Editing by Amanda Cooper and Bernadette Baum)