Bund yields near 9-month high, discount to Treasuries hits lowest since June 2023

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US borrowing costs drop sharply after data

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ECB policy rates seen stable through 2026

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Markets price a 55% chance of a rate hike in March 2027

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Analysts cautious as euro zone inflation is expected to undershoot

(Updates with latest prices)

By Stefano Rebaudo

Dec 11 (Reuters) - Euro zone benchmark government bond yields hovered near nine-month highs in late trading on Thursday, as investors shifted focus to next week's European Central Bank meeting after the Federal Reserve cut rates as expected.

Benchmark 10-year U.S. Treasuries yields were down 4.3 basis points at 4.12% after U.S. economic data. The Fed on Wednesday offered a less hawkish outlook than some investors had anticipated and announced larger purchases of short-dated bills, which lowered U.S. borrowing costs.

Yields on German 10-year Bunds, which serve as the benchmark for the euro zone market, were down 1.4 bps at 2.842% on Thursday. They hit 2.894% on Wednesday, their highest since mid-March. The gap between U.S. and German yields dropped to 126.01, its lowest since June 2023.

STRONG ECONOMIC DATA

Early this week, a batch of strong economic data and comments from ECB policymaker Isabel Schnabel, who said a rate hike was more likely than a cut, pushed Bund yields to their highest since March, when Germany unveiled a massive increase in fiscal spending.

Meanwhile, German 30-year yields hit their highest in more than 14 years, as long-dated debt came under pressure from worries over fiscal spending and heavier bond supply.

ECB President Christine Lagarde said on Wednesday the economy was proving resilient and the central bank could lift growth projections next week, after reiterating that monetary policy was in a good place.

"With expected sub-2% inflation forecasts for the next three years, we see any following ECB rate change as a cut, not a hike, at least through late spring next year," said Carsten Brzeski, global head of macro at ING, adding that Schnabel's comments may not reflect the ECB's majority view.

"After that, the window for rate cuts will likely close, and fiscal stimulus that meets supply-side constraints could bring back inflationary pressures," he added, arguing that was a 2027 story, rather than one for 2026.

Markets have already changed their pricing of the ECB policy path, which is now roughly unchanged after the Fed.

Traders are pricing in around a 5% chance of an ECB rate cut next summer, from 40% in late November and almost 70% in mid-October. Derivatives markets have implied roughly a 55% chance of a rate hike by March 2027 since Tuesday.

"We see the ECB holding rates steady at 2.0% in both 2026 and 2027 due to inflation undershooting in contrast to market expectations of 37-bp worth of hikes," said Rune Thyge Johansen, macro analyst at Danske Bank.

Germany's 30-year yields, which are more sensitive to long-term fiscal concerns, were almost unchanged on the day at 3.454%, after hitting 3.488% on Wednesday, the highest since summer 2011.

Yields on the German 2-year Schatz dropped 2.1 bps to 2.162%. (Reporting by Stefano Rebaudo; Additional reporting by Amanda Cooper; Editing by William Maclean, Mark Potter and Alison Williams)