Euro zone yields drop, equities rally pauses

(Updates prices at 1300 GMT)

By Tom Westbrook and Alun John

SINGAPORE/LONDON, Dec 5 (Reuters) -

Germany's 10-year government bond yield dropped to its lowest in six months on Tuesday and world shares edged off four-month highs as traders upped bets on European Central Bank rate cuts early in 2024 and grappled with the Federal Reserve's outlook.

The 10-year Bund yield dropped as much as 7 basis points to 2.28%, its lowest since June 2, after European Central Bank official Isabel Schnabel said in an interview with Reuters that further interest hikes are "rather unlikely", after an unexpectedly big fall in inflation.

Bond yields move inversely to prices and government bonds in most developed markets globally took a battering in 2022 and earlier this year after a rapid rise in central bank policy rates.

"The final nail in the coffin for further rate hikes, even if no one was expecting any," said Andrzej Szczepaniak, senior economist at Nomura, of Schnabel's comments.

Traders are now close to fully pricing in a 25 basis point rate cut from the European Central Bank at its March meeting, and nearly 150 basis points of cuts by the end of 2024.

The euro was down 0.2% at $1.0815.

Rate cuts are also expected in the U.S. with traders seeing 50 basis points of cuts as more likely than not by June. The 10-year U.S. Treasury yield was down around 6 basis points at 4.228%, walking back some of the previous day's 6-basis-point rise.

"The market has more or less priced the soft landing scenario (for the U.S. economy) to perfection," Bank of Singapore strategist Moh Siong Sim said. "Overnight there was a bit of a reality check - maybe it was too ambitious."

U.S. job openings data is due at 1500 GMT, and the week's most important data release, U.S. nonfarm payrolls data, which last month showed signs of a slowdown in the job market, will be published on Friday.

Equity markets retreated somewhat on Tuesday with the MSCI world index down 0.17%, edging off a four-month high hit Monday after a storming November, when the expected rate cuts powered stocks higher in the U.S. and Europe.

Europe's broad STOXX 600 index was up 0.15%, though U.S. S&P 500 futures dipped 0.38%. Earlier in the day, MSCI's broadest index of Asia-Pacific shares outside Japan fell 1.1%, with Chinese shares a drag.

Chinese blue chips fell 1.9% and are at their lowest level since early 2019, while Hong Kong's Hang Seng Index is down more than 17% for the year so far. World stocks are up almost 15%, as investors have streamed out of Chinese assets while the economy stumbles.

Late in Asian trading, ratings agency

Moody's cut its outlook

on China's government credit ratings to negative from stable, citing lower medium-term economic growth and risks from a major correction in the country's vast property sector.

DOVISH RBA

The Australian dollar was the biggest mover among developed market currencies, falling 0.85% to $0.6563 after the central bank left interest rates on hold, as expected, but emphasised that the future direction rates would depend on data.

"We suspect that markets were expecting a more hawkish statement given the unusually long time before the next (Reserve Bank of Australia) meeting on 6 February," Lenny Jin, global FX strategist at HSBC, said.

"The RBA did not forcefully push against the ongoing trend of easing financial conditions that has occurred globally since November."

Falling coal and gas prices pushed Australia's current account into deficit in the September quarter, data on Tuesday showed.

In commodity trading, Brent crude futures was last roughly flat at $77.93 a barrel, having fallen overnight on doubts that producers will make further cuts to output.

Chicago wheat held near its highest level since late August after the U.S. Department of Agriculture confirmed the largest one-off private sale to China in years.

Gold hung on above $2,000 after a wild session on Monday, when it hit a record high in Asia before recoiling sharply lower.

(Editing by Kim Coghill and Andrew Heavens)