Euro Zone Bond Yields Dip Amid Cooling June Inflation

Euro zone government bond yields slightly dipped as June's inflation data showed a cooling trend. Germany’s 10-year bond yield decreased by one basis point, while inflation fell to 2.5%. Core inflation remained at 2.9%. Analysts predict cautious movements from the European Central Bank. Market activity was influenced by political events in France.

Euro zone government bond yields were slightly lower on Tuesday after data showed euro zone inflation cooled in June, as the market steadied after sharp rises the previous day. Germany's 10-year bond yield, the benchmark for the euro zone bloc, was down one basis point (bp) at 2.59%.

Figures showed that euro zone inflation fell to 2.5% in June from 2.6% in May, as economists expected. Yet core inflation - which strips out volatile food and energy costs - came in at 2.9%. That was unchanged from May and above expectations for a fall to 2.8%.

"It already seemed unlikely that the European Central Bank would cut interest rates at its meeting in July, and June's inflation data will reinforce policymakers' inclination to move very cautiously," said Jack Allen-Reynolds, deputy chief euro zone economist at Capital Economics. Benchmark 10-year U.S. Treasury yields dipped on Tuesday following jobs market data and comments by Federal Reserve Chair Jerome Powell that monetary policy is closer to the tradeoff point where rate cuts are appropriate.

The euro zone is "very advanced" on the disinflationary path but there remain "question marks" over the economic outlook, European Central Bank President Christine Lagarde said. Italy's 10-year yield was down 3.5 bps at 4.07%, around its highest in three weeks. The gap between Italian and German bond yields dropped to 146 bps.

Germany's two-year bond yield, which is more sensitive to ECB rate expectations, was down 1.5 bps at 2.91%. Bond yields rose sharply on Monday as a rally in safe-haven bonds, driven by French President Emmanuel Macron's gamble in calling snap elections in early June, unwound after the results of the first round came in. Bonds are seen as more stable than stocks and preferable at times of stress.

Marine Le Pen's far right Rassemblement National party comfortably won the first round. Analysts said the market was comforted by signs that the most likely outcome is a hung parliament, however, prompting a rally in stocks and the euro. The second round of voting is on Sunday and the final shape of the French parliament will depend on horse-trading between the groups opposing Le Pen.

France's 10-year yield was 2 bps lower at 3.33%. The gap between France and Germany's 10-year yields - a gauge of the risk premium investors demand to hold French debt - ticked down to 72 bps.

It fell on Monday as the results came in, after rising to its highest since 2012 at 85 bps last week. Policymaker Pierre Wunsch said it is a relatively easy decision to cut rates again, but after that it depends on more progress on inflation.

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