Euro zone bond yields dip ahead of ECB, staff forecasts and euro in focus

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Investors reduce bets on ECB rate hikes after Schnabel's remarks fade

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German finance agency to announce 2026 bond issuance plans

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Italy's bond yield gap with Bunds hits 16-year low

By Stefano Rebaudo

Dec 18 (Reuters) - Euro zone government bond yields edged down on Thursday, with investors bracing for the European Central Bank to reaffirm its higher-for-longer rate stance later in the day. Investors pared back bets on future ECB rate hikes earlier this week as the impact of recent remarks by ECB board member Isabel Schnabel faded. Gilt yields rose after the Bank of England signalled caution about additional rate cuts.

Germany's 10-year yields, the euro area's benchmark, were down 1.5 basis points (bps) at 2.85%. They hit 2.894% last week, their highest level since mid-March. ECB staff projections will be closely watched, even if markets may have already priced in some changes after President Christine Lagarde noted that the central bank could lift its growth forecasts. Money markets priced in an around 15% probability of a tightening move by December 2026 and a 35% chance by March 2027, down from over 50% last week. The ECB depo rate is currently at 2%.

"The ECB's ongoing tolerance for currency strength in nominal terms, a far bigger driver this year of the euro's real effective exchange rate, has barely featured in discourse," said Geoff Yu, EMEA macro strategist at BNY. He said the "ECB cannot lose sight of exchange rate competitiveness."

"European leaders are pointing to China as the biggest risk to European manufacturing jobs, with currency valuations a core part of the issue," he added. The strength of the euro is amplifying the deflationary effect of China's export machine, which may end up being the catalyst that could jolt the European Central Bank out of its "good place" and into more rate cuts.

German 30-year yields were down 0.5 bps at 3.48%, after hitting 3.498% last week, their highest level since July 2011, as long-dated debt came under pressure on expectations for heavier bond supply. The German finance agency will hold a press conference on Thursday, announcing its bond issuance plans for 2026. Commerzbank expects total Bund issuance to reach around 350 billion euros next year, up from 291 billion euros this year.

Yields on German 2-year Schatz fell 0.5 bps to 2.14%.

Italy's 10-year government bond yields dropped 2.5 bps to 3.51%, with the gap versus Bunds at 65.50 bps, after hitting a fresh 16-year low at 64.40 bps earlier in the session.

(Reporting by Stefano Rebaudo; Editing by Ros Russell and Sharon Singleton)