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German borrowing costs fall after US data but French risk premium rises

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Updates at 1515 GMT

By Stefano Rebaudo and Harry Robertson

June 13 (Reuters) -German government bond yields fell on Thursday after U.S. data showed an unexpected drop in producer prices, supporting expectations that central banks will ease monetary policy, but the risk premium on French bonds widened to the highest since early 2023.

Data showed U.S. producer prices fell 0.2% last month, below analysts' forecast of a rise of 0.1%. Separate figures showed U.S weekly jobless claims rose to a 10-month high, suggesting the labour market is cooling.

Yields in the euro zone recorded their biggest daily fall since mid-May on Wednesday after economic data showed U.S. inflation was softer than expected. However, they rose in the morning session on Thursday after new forecasts showed Federal Reserve policymakers' median projection is now for only one interest rate cut this year, down from three in March.

Germany's 10-year yield DE10YT=RR, the benchmark for the euro area, was last down 2 basis points (bps) to 2.513%. It hit 2.707% at the end of May, its highest level since mid-November.

"As we heard in the recent press conference, the Federal Reserve saw modest progress with inflation dynamics and we expect future inflation reports will solidify their view," said Jeffrey Roach, chief economist for LPL Financial.

"Given the macro landscape, the Fed will likely begin cutting rates later this year."

Politics-driven jitters about euro zone bonds continued on Thursday, with the premium investors demand to hold French debt over German bonds rising sharply.

The spread between French and German yields DE10FR10=RR climbed to 69 bps, according to LSEG data, the highest since March 2023. The French 10-year yield FR10YT=RR was last up 4 bps to 3.195%.

French financial assets are saddled with political uncertainty and investor fears that a far-right government, if it wins power in the upcoming snap parliamentary election, could worsen France's long-term fiscal sustainability.

French President Emmanuel Macron urged rival parties on Wednesday to join his electoral alliance against Marine Le Pen's far-right National Rally.

Gains by the far right in voting for the European Parliament on Sunday may complicate European Union attempts to deepen integration, increasing the risk premium investors demand to hold bonds of the most indebted countries.

Italian bonds have also been hit by risk-aversion among investors. Italy's 10-year yield IT10YT=RR were last up 5 bps to 3.97%, with the gap between Italian and German yields DE10IT10=RR widening 8 bps to 145 bps.

Germany's 2-year government bond yield DE2YT=RR, more sensitive to policy rate expectations, was down 5 bps at 2.918%.

Money markets priced in 38 bps of further European Central Bank rate cuts in 2024, implying a second cut fully priced in and a roughly 50% chance of a third this year EURESTECBM4X5=ICAP. They discounted 49 bps of Fed cuts from 44 bps before data. FEDWATCH

Reporting by Stefano Rebaudo and Harry Robertson; editing by Alexander Smith, Mark Heinrich and David Evans


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