By Stefano Rebaudo

Oct 17 (reuters) - Euro zone benchmark Bund yields were on track for their biggest weekly drop since late March on Friday, as persistent U.S.-China trade tensions and signs of credit stress in the U.S. banking sector drove investors into safe-haven assets.

China on Thursday accused the United States of stoking panic over its rare earth controls and rejected a White House call to roll back the curbs.

U.S. bank stocks, including regional lenders Zions Bancorporation and Western Alliance, fell sharply on Thursday as investors grew uneasy about risk in the sector, which has been shaken by exposure to two auto bankruptcies.

Germany’s 10-year Bund yields DE10YT=RR, the bloc’s benchmark, were down 2 basis points (bps) at 2.58%, after hitting 2.523%, the lowest since June 25.

They were set to end the week 9 basis points lower, which would be the biggest drop since the final week of March, when yields fell sharply amid concerns over the deflationary impact of U.S. tariffs.

"Apart from the downward drift also to euro rates, the renewed flight to quality has clear implications for the German Bund, which is proving its role as a safe haven with yields dipping further below swaps," said Michiel Tukker, senior European rates strategist at ING.

Money markets ramped up bets on European Central Bank rate cuts, with concerns that credit stress could weigh on economic growth.

They priced in about an 80% chance of a 25 bp ECB rate cut by July EURESTECBM7X8=ICAP, up from around 65% on Thursday. The key rate is seen at 1.80% in December 2026 from the current 2% EURESTECBM10X11=ICAP.

“While concerns over credit should not be dismissed, there doesn’t seem to be any reason for economists to revaluate their economic outlooks at this stage," said Paul Donovan, chief economist at UBS Wealth Management.

“Middle-income households still have strong balance sheets with low debt levels,” he added.

Germany’s 2-year yields DE2YT=RR, more sensitive to expectations for ECB policy, dropped 3.5 bps to 1.89%.

The yield gap between safe-haven Bunds and 10-year French government bonds DE10FR10=RR - a market gauge of the risk premium investors demand to hold French debt - widened 4 bps to 78.50 bps.

It hit 87.96 bps earlier this month, the widest since January 13, on concerns about the French fiscal outlook but narrowed to below 75 bps after Prime Minister Sebastien Lecornu survived two no-confidence votes in parliament on Thursday.

Italy’s 10-year bond yields IT10YT=RR hit a fresh 10-month low at 3.342% and were last flat at 3.36%.

(Reporting by Stefano Rebaudo; editing by Kirsten Donovan)

((stefano.rebaudo@tr.com))