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Euro zone sovereign bond yields fall ahead of inflation data

Euro zone government bond yields fell on Monday, with investors awaiting inflation data due later this week that could affect expectations for interest rate cuts in 2024.

Money markets scaled back their bets on policy rate reductions last week as European Central Bank (ECB) policymakers warned about “too optimistic” bets on future cuts.

Market participants expect ECB President Christine Lagarde to reiterate that the central bank is in wait-and-see mode later in the session when addressing the European Parliament’s Committee on Economic and Monetary Affairs.

Germany’s 10-year government bond yield DE10YT=RR dropped 4.5 basis points (bps) to 2.60%. On Friday, it hit 2.663%, its highest level since mid-November.

“We advise investors to hold their nerve as the outlook for monetary policy continues to move,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.

“While recent data suggests that inflation is falling faster than expected, disappointments remain possible and central bankers are eager to stress their commitment to hitting their targets,” he added.

Money markets are currently pricing in 85 bps of rate cuts by December 2024 EURESTECBM9X10=ICAP from 100 bps in mid-November, while pricing an around 55% chance of a first 25 bps rate cut in April from about a 90% chance ten days ago.

“The hawk’s last argument is to highlight the upsurge in wages, but this is the most lagging indicator in the business cycle. There is every reason to debate monetary easing in the euro zone,” said Bruno Cavalier, chief economist at Oddo.

Some analysts see an economic slowdown in 2024 that will lead ECB policymakers to ease monetary policy aggressively.

Deutsche Bank said the euro area “was on course for nearly two years of stagnation by mid-2024” and “the ECB will likely cut 100 bps from June to year-end 2024.”

The budget crisis in Germany is also in focus as its outcome might affect the bloc’s fiscal policy, which European Union member states are currently discussing.

Germany’s ruling coalition is expected to agree a supplementary budget on Monday that will temporarily lift a self-imposed cap on borrowing limits after a constitutional court ruling tore up the government’s spending plans.

“Germany will probably suspend the debt brake for 2023, (and) tighten fiscal policy for 2024 and 2025,” said Holger Schmieding, economist at Berenberg.

“It remains an open question whether it (the German budget crisis) may affect the ongoing discussions about a reform of the EU’s fiscal rulebook,” he added.

Some analysts reckoned that easier fiscal rules in Germany could lead to a European agreement more focused on growth than on stability, as Italian Prime Minister Giorgia Meloni urged.

Italy’s 10-year government bond yield IT10YT=RR, the benchmark for the euro area’s periphery, fell 7.5 bps to 4.37%.

The spread between Italian and German 10-year bond yields – a gauge of premium investors ask to hold debt of the bloc’s most indebted countries – was at 171.5 bps. It hit last week 169.5 bps, its tightest since Sept. 21.
Source: Reuters (Reporting by Stefano Rebaudo, Editing by Toby Chopra and Mark Potter)

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