Euro area short-dated yields drop, spreads widen on tariff fears

By Stefano Rebaudo

April 7 (Reuters) - Euro area short-dated yields fell on Monday after hitting a 2-1/2-year low on Friday as fears of a global trade war led investors to boost bets on European Central Bank monetary easing, pricing a 90% chance of a rate cut next week.

U.S. President Donald Trump warned foreign governments they would have to pay "a lot of money" to lift sweeping tariffs, characterising the duties as "medicine".

The German 2-year yield, more sensitive to ECB policy rates, dropped 6 basis points (bps) to 1.80%. It hit 1.751% on Friday, its lowest level since October 6.

Money markets priced in an ECB depo rate at 1.70% in December from 1.75% on Friday and 1.9% last week shortly before U.S. President Donald Trump announced U.S. tariffs. They also discounted a 92% chance of a 25 bps rate cut next week.

Germany's 10-year yield, the euro area's benchmark, fell 5.5 bps to 2.56%. It reached 2.487% on Friday, its lowest since March 4.

On March 5, German long-dated yields had recorded the biggest daily rise in decades as German parties reached an agreement for a massive ramp-up in fiscal spending on infrastructure and defence.

Italy's 10-year yields rose 4.5 bps to 3.80%. The yield gap between BTPs and Bunds -- a gauge of risk premium investors ask to hold Italian debt - was at 120 bps, after hitting 123.40 bps on Friday its highest since mid-January.

The yield gap between French and German bonds stood at 76 bps. (Reporting by Stefano Rebaudo; Editing by Toby Chopra)