LONDON, Jan 30 (Reuters) - Higher-than-expected Spanish inflation data jolted euro zone bond yields off two-week lows hit in early trading Tuesday on the back of market expectations of a European Central Bank rate cut as soon as April, and positive news from the U.S. Treasury.
Traders were also digesting German and French GDP data released on Tuesday showing the euro zone's largest economy shrank 0.3% in the fourth quarter and its second largest economy failed to grow, both in line with analyst expectations.
Germany's 10-year bond yield was last flat on the day at 2.24%. It dropped to as low as 2.198% in early trading, its lowest in two weeks but moved higher after data showed Spain's European-Union harmonised inflation rose 3.5% in the 12 months through January driven by higher electricity prices.
That was up from a 3.3% increase in the period through December, and above expectations of analysts polled by Reuters.
It raises concern that inflation data due from Germany and France on Wednesday, and the euro zone on Thursday could also come in higher and disrupt expectations that rate cuts are approaching, though the broad trend in recent months has shown that inflation is slowing.
"These spikes are obviously putting doubt on the forward monetary policy, but the European Union will look at the whole situation and the reality is that the economy continues to be sluggish and at a certain point with inflation close enough to their target they start to switch their focus," said Althea Spinozzi, head of fixed income strategy at Saxo Bank.
Euro zone yields have moved sharply in recent months on the back of swings in rate expectation, and markets are all but pricing in the first ECB rate cut as soon as April.
Germany's 10-year bund yield fell from above 3% in early October to below 2% in late December as markets bet central banks would be cutting rates as soon as March, rose in January as these bets were pushed back and dipped again as investors took away the message from last week's ECB meeting that cuts were not too far off.
Germany's two-year yield, which is sensitive to moves in rate expectations, was last 2 bps higher at 2.50%, having hit a three-week low on Monday.
European bonds were also helped by a fall in U.S. yields after the U.S. Treasury said late on Tuesday it expected to borrow $760 billion in the first quarter, $55 billion lower than the October estimate.
The smaller than expected amount was primarily due to forecasts for increased net fiscal flows and higher cash balance.
Italy's 10-year yield was 1 basis point higher at 3.75%, and the spread between Italy and Germany's 10-year yields was a touch wider on the day at 149 bps but still around its tightest in 22 months.
(Reporting by Alun John, editing by Ed Osmond)
