Euro zone yields nudge up, rate outlook overshadows global risks for investors

(Updates prices to Europe afternoon)

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Bond yields tick higher after upbeat US economic data

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Geopolitical risks fail to move the bond market

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Hopes for fiscal stimulus to boost German economy fading

By Stefano Rebaudo

Sept 25 (Reuters) - Euro zone government bond yields nudged higher on Thursday, tracking U.S. Treasuries after upbeat U.S. economic data, but rate volatility continued to ease with the European Central Bank expected to remain on hold until the end of 2026 Germany's 10-year yield, the benchmark for the euro zone, was 2.5 bps higher at 2.764%, after falling earlier in the session.

The 10-year U.S. Treasury yield rose nearly 5 bps to 4.1950%, its highest in three weeks, after data showed the U.S. economy

grew faster

than previously estimated in the second quarter, prompting traders to trim their expectations for a rate cut by the Federal Reserve next month.

Investors have recently strengthened their expectations for the European Central Bank to keep rates higher for longer, with money markets pricing in less than a 35% chance of a 25 bp rate cut by June. Germany's 2-year yield, more sensitive to ECB policy expectations, rose 2 bps to 2.044%, the highest since April, while the U.S. equivalent was last up nearly 6 bps at 3.657%.

Investors are focusing on the U.S. rate outlook and continue to show limited sensitivity to geopolitical developments, analysts said, even as Russian incursions into NATO airspace grow bolder and NATO's response becomes increasingly tense. The gap between yields on safe-haven German Bunds and 10-year French government bonds - a market gauge of the risk premium investors demand to hold French debt - was slightly wider at 82.8 bps. French OAT yields were up 3 bps at 3.603%. French unions will hold another day of protests on October 2 to put pressure on new Prime Minister Sebastien Lecornu over their demands to scrap a fiscal austerity programme. "The current situation is spawning tension between debt and economic-growth concerns, especially at the long end (of the curve)," said Sebastian Fellechner, analyst at DZ Bank, referring to French political risks and German economic expectations, and this "should keep the Bund yield in check for now".

German business morale unexpectedly declined in September as the economic outlook remained weak although consumer sentiment is set to rise slightly heading into October, while remaining in negative territory.

"Gone seems to be the hope that the new government and fiscal stimulus would finally lift the economy out of its endless stagnation," said Carsten Brzeski, global head of macro at ING. Italy's 10-year yield rose 4.4 bps to 3.632%. The yield spread over Bunds widened as far as 87.33 bps, its highest since September 4. It had dropped below 80 bps, the lowest since 2010, in mid-August. The Swiss National Bank held its key interest rate at zero on Thursday, the lowest among major central banks. (Reporting by Stefano Rebaudo and Jaspreet Kalra, editing by Ronojoy Mazumdar, Kirsten Donovan)