Euro zone government bond yields drop ahead of inflation data

Eurozone government bond yields dropped as investors await inflation data on both sides of the Atlantic, which might provide fresh clues about the central bank’s policy path. Analysts said the figures were unlikely to change expectations for the first European Central Bank (ECB) rate cut, which markets expect in June, but could affect bets on the following moves.

Spain's inflation rose 3.2% in the 12 months through March, just below the 3.3% expected by analysts polled by Reuters. "We think it (Spain's inflation) is likely to increase further over the coming months due to base effects in energy inflation, higher VAT rates on energy and foods, and services firms hiking prices," said Adrian Prettejohn, Europe Economist at Capital Economics.

"Meanwhile, the tightness of the labour market suggests that inflation could stay above 2% over the next couple of years." Investors await further clues about the consumer price dynamics in the next few days as France, Italy, and the U.S. will issue data on Friday, while German and euro area-wide figures are due next week.

Germany's 10-year bond (Bund) yield, the benchmark for the bloc, was last down 3 basis points (bps) at 2.32%. Leading German economic institutes said on Wednesday that they expected the country's economy to grow by 0.1% in 2024, slashing their prior forecast of 1.3%.

"While (inflation) figures are unlikely to deter the ECB from cutting rates in June, the market's view for around 90bp rate cuts this year may ultimately prove somewhat too optimistic," said Rainer Guntermann, strategist at Commerzbank. ECB euro short-term rate (ESTR) forwards fully price in an ECB rate cut by June and 92 bps by December 2024.

France's 10-year government bond yields dropped 2.5 bps to 2.8%, with the gap with the safe-haven Bund briefly hitting a fresh 4-week high at 50 bps. It was at around 43 bps last week. France's public sector budget deficit widened last year by more than the government planned, data showed on Tuesday.

Analysts said France's spread volatility was limited on Tuesday as some of the official figures had already been leaked and flagged that markets have turned a blind eye to excessive deficits in the bloc. "Many eurozone countries continue to face fiscal pressure, and upcoming elections pose political uncertainties," said ING rate strategists led by Padhraic Garvey.

"We therefore shouldn't entirely bank on the idea that (yield) spreads will have a smooth ride throughout the upcoming rate-cutting cycle." Italy's 10-year yield fell 2.5 bps to 3.63%.

The spread between Italian and German yields – a gauge of risk premium investors ask to hold government bonds of the euro area's most indebted countries - was at 129 bps. It hit 115.40 bps, the lowest in more than 24 months in mid-March.

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