Euro area yields plunge, markets price in ECB depo rate at 1.65% in December

By Stefano Rebaudo

April 7 (Reuters) - Euro area short-dated government bond yields hit fresh 2-1/2-year lows on Monday as investors boosted bets on future European Central Bank rate cuts, responding to fears about the economic impact of U.S. tariffs.

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".

German two-year yield, more sensitive to the ECB policy rates, dropped 12.5 basis points (bps) to 1.687%, its lowest level since early October 2022.

Money markets priced in an ECB depo rate at 1.65% 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 90% chance of a 25 bps cut next week.

"Markets are testing Trump's resolve, but the U.S. President is still standing firm," said Rainer Guntermann, rate strategist at Commerzbank.

Germany's 10-year yield, the euro area's benchmark, fell 9.5 bps to 2.53%. It reached 2.487% on Friday, its lowest since March 4.

On March 5, German long-dated yields 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 investment.

A massive selloff in risky assets included Italian government bonds, with the 10-year yield rising 2.5 bps to 3.84%.

The yield gap between BTPs and Bunds - a gauge of risk premium investors ask to hold Italian debt - reached 124 bps its highest since mid-January.

European Central Bank policymaker Isabel Schnabel said that the euro zone economy's long-standing structural headwinds have been exacerbated by a surge in uncertainty, which may get even worse in the wake of U.S. trade tariffs.

The yield gap between French and German bonds rose to 77 bps.

(Reporting by Stefano Rebaudo, Editing by Andrew Cawthorne)