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Euro zone yields up as investors weigh inflation data against Fed outlook

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Replaces 'he' with 'she' in the seventh paragraph

By Stefano Rebaudo

June 13 (Reuters) -Euro zone borrowing costs edged up on Thursday as investors balanced recent weak U.S. inflation data against Federal Reserve policymakers' median projection, which brings the number of interest rate cuts this year to just one from three in March.

The bloc's yields recorded their biggest daily fall since mid-May on Wednesday after economic data showed U.S. inflation was softer than expected.

Fed Chair Jerome Powell noted on Wednesday that inflation had fallen without a major blow to the U.S. economy, and he said there was no reason to think that cannot go on.

Money markets priced in 58 bps of European Central Bank rate cuts in 2024, from around 63 bps on Wednesday before the Fed statement, implying one move in 2024 and an around 30% chance of a third cut in 2024. EURESTECBM4X5=ICAP

They discounted 44 bps of Fed cuts from 51 bps on Wednesday before the outcome of the policy meeting. FEDWATCH

"There will be three more inflation reports before the Sept 18 FOMC meeting," said Xiao Cui, senior economist at Pictet Wealth Management, after flagging that the Fed committee was very much divided.

"We expect continued good readings on inflation to enable the Fed to start cutting then, but the risk continues to be that the disinflation path is bumpy, and a cautious Fed might need to see more months of good readings only to start cutting in December," sheadded.

Germany's 10-year yield DE10YT=RR, the benchmark for the euro area, was up one basis point (bp) at 2.54%. It hit 2.707% at the end of May, its highest level since mid-November.

"U.S. consumer price inflation emphasized disinflation forces," said Paul Donovan, chief economist at UBS Global Wealth Management.

"Almost every sector of the U.S. economy is in deflation somewhere in the US. Market determined prices continue to weaken, and durable goods are sinking deeper into deflation."

However, in the euro area, ECB policymakers have recently sounded cautious about the disinflation process, with vice-president Luis de Guindos saying the central bank must move "very slowly" in reducing rates, and Philip Lane arguing the ECB should wait with its next cut until uncertainty recedes.

Germany's 2-year government bond yield DE2YT=RR, more sensitive to policy rate expectations, was up 1.5 bps at 2.98%. It recently hit 3.125%, its highest since mid-November.

The spread between French and German yields DE10FR10=RR -- a gauge of the risk premium investors demand to hold French government bonds -- remained close to its highest level in around 15 months after French President Emmanuel Macron on Wednesday urged rival parties to join his electoral alliance against Marine Le Pen's far-right National Rally.

French financial assets are saddled with political uncertainty and investor fears that a far-right government could worsen France's long-term fiscal sustainability.

The French spread DE10FR10=RR was at 63 bps; it hit 66.9 earlier this week, its widest level since March 2023.

Reporting by Stefano Rebaudo, editing by Alexander Smith


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