June 6 (Reuters) - Euro zone government bond yields edged up on Thursday ahead of the European Central Bank policy meeting after investors recently increased their bets on future rate cuts.
Analysts have reckoned for weeks that a rate cut this month was a done deal, but there is a lot of uncertainty about the outlook after June.
Germany's 10-year yield, the bloc's benchmark, rose 3 basis points (bps) to 2.53%. It hit a 6-1/2 month high at 2.707% last Friday.
"As is widely anticipated, that should set up for a 'hawkish cut' today, with no firm commitment on the next move," said Jamie Searle, rates strategist at Citi.
"There could still be a hawkish surprise on the harmonized index of consumer prices (HICP) projection for 2025," he added, flagging that it was at 2% in March and that most analysts expect it to remain unchanged.
Money markets priced in 64 basis points of ECB monetary easing in 2024, increasing their bets from less than 55 bps early on Monday on the back of weaker-than-expected U.S. data, which led investors to discount more monetary easing from the Federal Reserve.
The spread between U.S. and German 10-year yields - a gauge of expectations for monetary policy divergence between the Fed and the ECB – was at 177 bps from around 195 bps late last week.
"Ideally, the signal (about the ECB rate outlook) would be a steady rhythm of rate reductions - a quarter point a quarter, reflecting ongoing disinflation as evidenced in yesterday's producer price data," said Paul Donovan, chief economist at UBS Wealth Management.
"The risk is that ECB President Lagarde introduces deliberate uncertainty," he added.
Dutch central bank chief Klaas Knot said last month the ECB decisions on future cuts could center around quarterly meetings.
Germany's 2-year government bond yield, more sensitive to policy rate expectations, was up 1.5 bps at 2.99%. It hit 3.125% on Friday, its highest since mid-November.
The most unexpected outcome would be if the ECB signaled that the July meeting is live for a back-to-back rate cut, a move the markets currently priced in with less than a 5% chance.
The Bank of Canada trimmed its key policy rate on Wednesday, indicating further easing would be gradual and dependent on data, but analysts expect the ECB to sound less dovish.
Italy's 10-year yield rose 3 bps to 3.83%.
The gap between Italian and German yields, a gauge of the risk premium investors seek to hold bonds of the euro area's most indebted countries, was at 130 bps. (Reporting by Stefano Rebaudo, editing by David Evans)
