Euro zone yields dip on U.S. tariffs threat to ECB policy

By Abhinav Ramnarayan

LONDON (Reuters) - Euro zone government bond yields fell on Wednesday on speculation that planned U.S. import tariffs including on goods from Europe could impede the European Central Bank's plan to withdraw post-crisis monetary stimulus.

U.S. President Donald Trump's top economic adviser, Gary Cohn, resigned on Tuesday in a move that could ramp up protectionist measures which risk igniting a global trade war.

This fuelled demand for safe-haven government bonds, and U.S. Treasury yields extended overnight falls.

In Europe, demand for government bonds stepped up on Wednesday, the day before an ECB meeting at which policymakers are expected to provide more detail on when the central bank will wind up its massive bond buying scheme.

But analysts said the message could be complicated by U.S. events. "The fear in the market is that a global trade war could influence economic growth in Europe, and if growth is lower there is more danger of a recession and the ECB might be forced to be slower in reducing accommodation," said DZ Bank analyst Pascal Segesser.

Commerzbank analysts also flagged this possibility in a note, saying Cohn's resignation increases the chance of a more dovish message from the ECB on Thursday.

Most euro zone government bond yields fell 2-5 basis points. The yield on Germany's 10-year government bond, the benchmark for the region, was down nearly 2 bps at 0.66 percent.

Lower-rated southern European debt -- seen as more dependent on loose ECB policy -- outperformed, with yields falling 3-7 basis points. Portuguese 10-year yields fell to a more than one-month low of 1.837 percent, before inching up to 1.857 percent.

Data showing U.S. private-sector jobs increased by 235,000 in February briefly put some upward pressure on bond yields, coming before Friday's closely-watched non-farm payrolls report.

The U.S. Federal Reserve's Lael Brainard said that she has greater confidence that gradual interest rate increases are needed.

BREATHING ROOM

Meanwhile, the Italy-Germany 10-year yield spread tightened further to 140 bps and was approaching pre-election levels on Tuesday, as investors appeared to put last weekend's inconclusive vote behind them.

Former prime minister Silvio Berlusconi said in a newspaper interview on Wednesday he will support the leader of the eurosceptic League party in attempts to form a government.

Yet the effect on spreads and on the euro was minimal; the common currency was higher at $1.2410.

"Spreads more broadly may have some more breathing room as the actual government formation discussions in Italy do not look set to kick off for real until later this month when parliament convenes for the first time," ING strategists said in a note.

(Reporting by Abhinav Ramnarayan; Editing by Catherine Evans and David Stamp)