Euro Zone Bond Yields Fall Amid Lower-than-Expected Inflation Data

Euro zone government bond yields dropped as France and Spain posted lower-than-expected inflation figures, influencing investor expectations for European Central Bank rate cuts. While France saw a smaller rise in consumer prices, Spain's inflation fell to 1.7%. Markets now await U.S. PCE inflation data, which could impact monetary policy outlooks.

Euro zone government bond yields fell on Friday following inflation data from France and Spain that fueled investor expectations for future rate cuts by the European Central Bank (ECB).

French consumer prices rose less-than-expected in September, helped by a drop in energy costs, while Spain's harmonized inflation over 12 months fell to 1.7%, below the anticipated 1.9%. German and euro area figures are expected next week.

Germany's 10-year bond yield, the benchmark for the euro zone, dropped 6 basis points to 2.11%. According to Franziska Palmas, senior European economist at Capital Economics, lower core inflation is unlikely to significantly change ECB policymakers' outlook.

Money markets now price an 80% chance of an ECB rate cut in October, up from 20% earlier this week. Forwards on the ECB euro short-term rate (ESTR) indicate a 50 basis-point cut by year-end. Markets are closely watching U.S. Personal Consumption Expenditure (PCE) data, the Federal Reserve's preferred inflation gauge, which could affect future monetary policies.

Germany's two-year bond yield, sensitive to ECB rate expectations, hit its lowest since December 2022 at 2.065%. The yield gap between French and German 10-year bonds reached 78 basis points, influenced by France's budget deficit risks warned by Budget Minister Laurent Saint-Martin. Italy's 10-year yield also saw a drop, tightening the gap between Italian and German yields to 130 basis points.

(With inputs from agencies.)