Euro zone bond yields fall after ECB officials talk up cuts

Euro zone government bond yields fell on Monday after European Central Bank officials said they have room to cut interest rates as inflation slows, ahead of key economic data later this week.

“Barring a surprise, the first rate cut in June is a done deal, but afterwards we have several degrees of freedom,” French central bank chief Francois Villeroy de Galhau told Germany’s Boersen Zeitung.

ECB chief economist Philip Lane told an audience in Dublin that easing too late risked pushing inflation below target, although he also said cutting too fast could risk a flare-up of price pressures.

Germany’s 10-year bond yield, the bloc’s benchmark, dropped 5 basis points (bps) to 2.536%. The yield, which moves inversely to the price, had touched a one-month high of 2.618% on Friday after survey-based data showed the euro zone economy brightened in May.

Investors will focus on the German consumer price index on Wednesday, along with euro area inflation figures and the US personal consumption expenditure index on Friday. The ECB’s consumer expectations survey will be released on Tuesday, and the Federal Reserve’s Beige Book on Wednesday.

“Our economists broadly concur with the consensus that headline (euro area) inflation should tick up while the decline in core inflation is likely to stall,” Hauke Siemssen, rate strategist at Commerzbank, said.

“This outcome could add spice to the ECB’s assessment that headline and core inflation dynamics are both decelerating.”

Money markets last priced in 60 basis points (bps) of ECB monetary easing in 2024, which implies two rate cuts and an around 30% chance of a third move by year-end.

The ECB is ready to cut interest rates next month but policy must continue to be restrictive this year as wage growth will not normalise until 2026, ECB chief economist Philip Lane said in an interview with the Financial Times, also published on Monday.

Germany’s two-year government bond yield, more sensitive to policy rate expectations, was down 6 bps at 3.027% after hitting 3.124% on Friday, its highest since mid-November.

German business morale stagnated in May, falling short of a forecast improvement, according to a survey on Monday.

Italy’s 10-year yield was down 6 bps at 3.828%, while the gap between Italian and German yields was at 129 bps.

The spread between US 10-year Treasuries and German bunds – a gauge of the expected policy path divergence between the ECB and the Fed – widened 5 bps to 193 bps.

BofA economists expect the divergence between the ECB and the Fed monetary policy to be wider than the current market expectations and the spread between US and German yields to break recent peaks by year-end.

(Reporting by Stefano Rebaudo and Harry Robertson; Editing by Sriraj Kalluvila, Susan Fenton and Andrew Heavens)