UPDATE 3-Euro area yields set for weekly rise as markets price fewer ECB rate cuts

(Recasts with rebound in yields, adds comments)

By Stefano Rebaudo

LONDON, April 26 (Reuters) - Euro zone government bond yields were on track for the second straight weekly rise as market expectations for cumulative European Central Bank rate cuts this year dropped way below 75 basis points on the back of strong U.S. economic data.

Germany's 10-year bond yield, the benchmark for the eurozone bloc, fell 5 bps to 2.61% but is set for a weekly rise of 7 bps after being up 15 bps the week before.

Investors scaled back bets on 2024 ECB monetary easing by around 10 bps to 65 bps on Thursday on news of U.S. economic growth, even at its slowest pace in nearly two years. Signs of solid demand and an acceleration in inflation reinforced expectations that the Federal Reserve would not cut interest rates before September.

ECB euro short-term rate (ESTR) forwards last priced 67 bps of cuts in 2024.

U.S. monthly data released on Friday showed inflation rose moderately in March. However, stubbornly higher housing and transportation costs also suggested the Fed could keep rates elevated for a while.

Some analysts say it would be difficult for the ECB to cut rates substantially while the Fed is still on hold because of the effect on the single currency.

Markets currently price in 37 bps of Fed monetary easing in 2024, which implies one 25 bps move and a less than 50% chance of a second cut.

"A rapid devaluation (of the euro) would be out of place and would rekindle concerns about more imported inflation, especially as the oil price has already risen again," said Ulrike Kastens, European economist at DWS, after flagging risks of euro weakening on higher U.S. rates.

However, markets seem unwilling to price in more divergence between the Fed and the ECB as they expect an ECB rate cut in June but are highly uncertain about further developments.

The yield gap between Bund and 10-year Treasury yields - a gauge of expected divergence between the ECB and the Fed - tightened to 207 on Friday. It hit 220.92, its highest since the end of 2019, in mid-April.

The market focus is shifting to next week's Fed policy meeting as investors expect the U.S. central bank not to give up on signalling a monetary easing in 2024.

"All together, we see risks tilted towards slightly dovish market reaction if (Fed Chair Jerome) Powell maintains clear verbal guidance for rate cuts in 2024, even when emphasizing that there is no urgent need to act for the time being," said Antti Ilvonen, associate U.S. macro at Danske Bank.

"Our call for rate cuts starting already in June is inarguably under pressure, but we still like our view for three cuts in total in 2024," he added.

On Friday, Italy's 10-year yield was lower by 9 bps at 3.89%, and the gap between Italian and German Bunds narrowed 4 bps to 130 bps. (Reporting by Stefano Rebaudo; Additional reporting by Alun John; Editing by Richard Chang)