Euro Zone Bond Yields: A Mixed Reaction to Inflation Data

Euro zone government bond yields showed mixed reactions on Friday following inflation data from the euro area and the U.S. Analysts remain uncertain about the future inflation outlook, with key rates remaining relatively stable. Market participants still expect ECB rate cuts in 2024, but recent communication provides little clarity on future plans.

Euro zone government bond yields were mixed on Friday after data from opposite sides of the Atlantic did not shift market bets on the European Central Bank's rate-cutting plans.

German 10-year Bund yields, the bloc's benchmark, had hit a fresh six-month high earlier in the session after euro area figures showed that inflation rose in May. The closely watched U.S. personal consumption expenditures (

PCE ) index - the Federal Reserve's favourite inflation gauge - tracked sideways, and a report from the Commerce Department showed tepid consumer spending.

Analysts remained uncertain about the inflation outlook after the bloc's figures

. "We are aware of country-specific, one-off factors that may have affected the May inflation print," said Andrzej Szczepaniak, economist at Nomura, after recalling that services inflation jumped to 4.1%.

"Publication of the granular details should allow us to determine whether any part of the strengthening in underlying momentum is broad-based, rather than wholly attributable to these country-specific one-off factors," he added. The German 10-year yield was last 0.5 basis points (bps) lower at 2.65%, after hitting 2.707%, its highest since mid-November.

The increase in the euro zone inflation was expected and the data is "neither good nor bad," ECB governing council member Fabio Panetta

said on Friday." Markets are currently pricing around 57 bps of rate ECB rate cuts in 2024, at the same levels seen before the bloc's economic figures. Rate derivatives are indicating a 25-basis-point reduction in June, one more by year end, in addition to an around 30% chance of a third ECB move in 2024.

In recent weeks, however, they have been gradually paring back expectations of a third cut this year. "Since the inflation rate is currently lower than it was when the ECB ended its hiking cycle, the effective policy stance has automatically become more restrictive," Bas van Geffen, senior macro strategist at Rabobank, said.

"That may be unwarranted and requires a recalibration," he added, recalling market expectations for a 25-bps cut next week. "This does not mean that the ECB actively seeks to shift to neutral or accommodative policy yet." Germany's two-year yield, which is more sensitive to ECB rate expectations, was one bp higher at 3.09%, after reaching a more than six-month high at 3.125%.

The data will nonetheless shape the narrative at the ECB's meeting on June 6. Recent communication from rate setters indicate a rate cut is all but certain, but they have given few indications for their plans after that. ECB policymaker

Mario Centeno said on Friday the economic figures should still allow the ECB to start cutting rates.

Italy's 10-year yield was higher by 0.5 bps​ at 3.96%, and the gap between Italian and German bunds widened slightly to 131 bps.

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