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Sovereign bond investors on hold ahead of U.S. data, central bank meetings

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By Stefano Rebaudo

Dec 11 (Reuters) - Euro zone yields edged lower on Monday, with investors on hold ahead of a reading on U.S. inflation on Tuesday and policy meetings from major central banks later in the week.

Borrowing costs on both sides of the Atlantic jumped last Friday after robust U.S. economic data led money markets to scale back expectations for future rate cuts slightly.

Despite that, the benchmark 10-year Bund yield recorded on Friday its biggest biweekly fall since mid-March as money markets ramped up bets on European Central Bank rate cuts.

Barring the mid-March fall – when bond yields had tumbled on the collapse of Silicon Valley Bank (SVB) - the Bund yield recorded its most significant biweekly drop since the end of July 2011. It was last down 1.5 basis points (bps) at 2.25% after rising 7.5 bps on Friday.

Money markets priced 135 basis points of policy rate reductions in 2024, from around 145 bps late on Thursday. They priced 80 bps at the end of November.

Analysts brought forward their expectations for future cuts after weak inflation data and the aggressive market repricing, but they expect central banks to keep rates unchanged this week.

Goldman Sachs forecast the Federal Reserve to reduce rates for the first time in the third quarter 2024, while expecting the ECB to cut by 25 bps in each meeting starting April next year.

Citi analysts expect an ECB pushback against the recent market repricing of policy rates "to be quite soft" at this week policy meeting, and "a quantitative tightening (QT) discussion/decision" to widen the spread between 10-year Italian bond yields and the euro short-term rate by 5-15 bps, while being "relatively neutral" on bonds.

ECB President Christine Lagarde recently said it may discuss ending reinvestments early of its 1.7 trillion euro Pandemic Emergency Purchase Programme (PEPP), in a move which would reduce excess liquidity.

The Bank of England (BoE) looks set to stick to its tough line against talk of interest rate cuts in Britain, even as other leading central banks signal that they might be approaching a turning point in their fight against inflation.

The Fed will meet on Wednesday, while the ECB and the BoE will meet on Thursday.

Italy's 10-year yields, the benchmark for the euro area's periphery, was up 0.5 bps at 4.06%. The spread between Italian and German 10-year yields – a gauge of the risk premium investors ask to hold bonds of the most indebted countries – was at 179 bps after recently falling to 170 bps.

Investors are watching the negotiations for the reform of the European Union fiscal rules – the Stability and Growth Pact – as the resilience of peripheral spreads could be challenged if investors already nervous about debt sustainability and high rates are spooked by tight post-pandemic budget rules.

On Friday, German Finance Minister Christian Lindner insisted that EU deficits must be controlled when reforming the bloc's fiscal rules.

Markets will watch the Bank of Japan (BOJ) policy meeting on Monday next week, while investors weigh the chance that the BOJ could exit from negative interest rates as early as January.

Analysts have warned that a sharp rise in domestic yields could suck money back to Japan and out of global assets, including euro area and U.S. sovereign bonds. (Reporting by Stefano Rebaudo, Editing by Alex Richardson) ;))