Euro Zone Bond Yields Drop Amid Inflation Data

Euro zone government bond yields fell as inflation data from France and Spain bolstered expectations of European Central Bank rate cuts. French consumer prices rose less than expected in September. Spain's 12-month inflation dropped to 1.7%. Germany's 10-year bond yield decreased to 2.14%. Analysts anticipate further rate adjustments.

Euro zone government bond yields dropped on Friday after inflation data from France and Spain led investors to increase their bets on future European Central Bank rate cuts. French consumer prices rose less than anticipated in September, aided by a decline in energy costs. Spain's European Union-harmonised 12-month inflation eased to 1.7%, lower than the 1.9% expected by analysts polled by Reuters.

The German and euro area figures are due next week. Germany's 10-year bond yield, the benchmark for the euro zone bloc, fell 3 basis points (bps) to 2.14%.

'Slightly lower core inflation in the euro zone wouldn't come as a big surprise to the ECB so would be unlikely to drastically alter policymakers' thinking,' said Franziska Palmas, senior European economist at Capital Economics. Money markets priced in an 80% chance of an ECB rate cut in October from around 20% early this week and 60% before data.

However, they are more inclined to discount a bigger move in December as forwards on the ECB euro short-term rate (ESTR) fully discounted a 50 bps cut by year-end. The ECB 'will have a stronger argument to continue cutting rates over the coming months,' said Charlotte de Montpellier, senior economist at ING.

'This is all the more true given that the moderation in inflation is set to continue in France.' Markets now await the U.S. Personal Consumption Expenditure (PCE) figures - the Federal Reserve's preferred inflation measure - later in the session, which could affect expectations for monetary policy paths on both sides of the Atlantic.

Some analysts expect limited impact from U.S. data as the recent shift in the Fed's focus to the employment side of its mandate made markets less sensitive to inflation. Germany's two-year bond yield, which is more sensitive to ECB rate expectations, hit its lowest level since December 2022 at 2.065%. It was last down 1.5 bps at 2.10%.

The gap between French and German 10-year yields - a gauge of risk premium that investors demand to hold France's government bonds - was last at 78 bps, up from around 70 bps two weeks ago. It reached its widest since 2012 during France's parliamentary election earlier this year, at beyond 85 bps.

French Budget Minister Laurent Saint-Martin said the deficit was at risk of topping 6% of economic output, far above the 5.1% that the previous government had estimated in the spring. He added that the government would focus a budget squeeze on spending cuts first and tax increases, amid calls for a realistic plan to rein in a fiscal shortfall which threatens France's credibility with financial markets.

Italy's 10-year yield fell 3.5 bps to 3.44% and the gap between Italian and German yields tightened slightly to 130 bps.

(With inputs from agencies.)