Euro Zone Bond Yields Drop Amid Anticipation of U.S. Inflation Data and ECB Decision

Euro zone government bond yields fell as investors awaited U.S. inflation data and the European Central Bank's interest rate decision. Kamala Harris' performance in the debate added pressure on U.S. interest rates, and trade tariffs under Trump could have mixed effects. Analysts expect market changes based on upcoming economic reports.

Euro zone government bond yields fell on Wednesday as investors hesitated ahead of the release of U.S. inflation data later in the session and Thursday's interest rate decision from the European Central Bank.

During Tuesday night's presidential debate, Kamala Harris put Donald Trump on the back foot, creating expectations for reduced U.S. interest rates. Investors predict trade tariffs and increased spending that could raise rates if Trump wins. This led U.S. benchmark 10-year yields to reach a fresh 15-month low of 3.60%, down 4 basis points (bps). Bond yields generally move inversely to prices.

For German Bunds, a Trump victory presents a more complex picture, some analysts argued. While trade tariffs could spur inflation, they might also burden the economy, lowering rates. Increased geopolitical tensions would further suppress global yields. Germany's 10-year yield, the euro zone bloc's benchmark, dropped 3.5 basis points to 2.11%, marking a fresh one-month low.

The primary focus on Wednesday remained the U.S. and its August consumer price index (CPI), set to be released later. Despite the Federal Reserve's renewed focus on the labor market, these figures could influence the first Fed cut next week after an inconclusive jobs report.

Citi analysts noted that a downside surprise in the consumer price index (CPI), with the core at 0.1%, might raise the market-implied likelihood of a 50 bps cut in September. They foresee a 0.204% month-on-month increase, leading Fed officials to use activity data like initial jobless claims and retail sales to determine the appropriate size of the first easing.

Money markets have fully anticipated a 25 bps cut by the Fed and a 33% chance for a 50 bps reduction this month. Additionally, they priced in approximately 60 bps of ECB rate cuts by 2024, suggesting two 25 bps moves and a 40% probability of a third cut.

Investors anticipate the ECB to slash policy rates by 25 bps on Thursday, with President Christine Lagarde emphasizing the central bank's commitment to data-dependency. Germany's two-year bond yield, more responsive to ECB rate expectations, decreased 4.5 bps to 2.15%, after reaching an 18-month low of 2.144%.

Italy's 10-year yield dropped by 5 bps to 3.50%, following a dip to 3.47%, its lowest since December. The spread between Italian and German Bunds—a measure of the risk premium for holding Italian government bonds—stood at 137 bps.

Italy's new extra-long bond, launched on Tuesday, drew record demand as the country's bond yields remain attractive ahead of the expected ECB interest rate cut.

(With inputs from agencies.)