June 18 (Reuters) - Euro zone government bond yields were mixed on Tuesday, with investors awaiting U.S. economic data later in the session while closely watching political developments in France.
The risk premium that investors demand to hold French government bonds dropped from its recent highs as markets hope that France's National Rally will backtrack on fiscally expensive pledges should it win upcoming parliamentary elections.
German 10-year bond yield, the benchmark for the euro area, rose 2 basis points (bps) to 2.43%.
The recovery in German investor morale tapered off in June, the ZEW economic research institute said.
Markets are currently pricing in another European Central Bank (ECB) rate cut and a roughly 50% chance of a third move in 2024.
Analysts have mixed views about a further rise in the French risk premium, but they expect uncertainty to remain high until the second round of the elections on July 7.
Investors could be cautious about selling French bonds more aggressively as the ECB could use the Transmission Protection Instrument (TPI), which allows it to buy unlimited amounts of bonds to avoid unwarranted and disorderly yield spread widening, which could hamper the transmission of the monetary policy. The ECB's chief economist, Philip Lane, said on Monday there was no need to come to France's rescue now because recent market turmoil fuelled by political uncertainty was "not disorderly".
ECB President Christine Lagarde said that the ECB would monitor markets because price and financial stability are closely linked.
The gap between French and German 10-year yields - a gauge of the risk premium on French government bonds – tightened 3 bps to 71 bps. It hit 82.34 bps on Friday, its highest level since February 2017.
Friday's rush into safe-haven assets made clear that investors weren't keen to go into the weekend with too much risk on their books, but the mood changed since Monday.
The leader of the far-right National Rally, Marine Le Pen, said during the weekend she was seeking cohabitation with President Emmanuel Macron.
"This (the Le Pen remarks) would increase the prospects that the current market rout will be resolved more like the BTP fears after (Giorgia) Meloni took office than the UK Gilt crisis in the wake of Liz Truss," said Christoph Rieger, head of rate and credit strategy at Commerzbank.
The Italian government debt risk premium dropped after Prime Minister Meloni took office as she assured Italy would abide by European fiscal rules.
Italy's 10-year yield fell 3 bps to 3.91%, with the Italian-German gap down 3.5 bps at 148 bps.
(Reporting by Stefano Rebaudo, editing by Kim Coghill)
