Euro Zone Bond Yields Fall Amid Weaker Inflation Data

Euro zone government bond yields dropped after weaker-than-expected inflation data from France and Spain. Anticipation of future European Central Bank interest rate cuts grew, pushing yields further down. Significant revisions in ECB rate forecasts by major banks and ongoing U.S. inflation trends contributed to the market movements.

Euro zone government bond yields fell on Friday following unexpectedly soft inflation data from France and Spain, leading investors to heighten their expectations for impending European Central Bank interest rate cuts. This sentiment was further bolstered by lower U.S. inflation data, pushing European yields down slightly more.

In September, French consumer prices rose less than predicted, helped by a dip in energy costs. Concurrently, Spain reported a 12-month inflation rate of 1.7%, below the 1.9% forecast by analysts. Anticipated German and euro area inflation figures are set to be released next week.

Germany's 10-year bond yield—the euro zone's benchmark—dipped by 3 basis points to 2.14%, while the two-year yield fell by 2 bps to 2.09%, hitting its lowest since December 2022. The shifts occurred as money markets increased the likelihood of an ECB rate cut in October to 80%, up from 20% earlier in the week and 60% before the new data. Banks like Goldman Sachs and JPMorgan adjusted their ECB rate path predictions to include an October cut, influenced by disappointing Purchasing Managers Index data and hints of lowering core inflation in French and Spanish CPI reports.

Purchasing Managers Index survey results revealed an unexpected contraction in euro zone business activity. Meanwhile, Friday data showed easing U.S. inflation pressures, with the personal consumption expenditures price index rising 0.1% month-on-month in August, aligning with expectations, and 2.2% year-on-year. This is the smallest gain since February 2021, down from July's 2.5%, tracking towards the U.S. central bank's 2% inflation target.

Both U.S. and European yields dropped slightly after the data release. The risk premium gauge between French and German 10-year yields was at 79 bps, up from 70 bps two weeks prior. During France's parliamentary election earlier this year, this spread had hit its widest since 2012 at over 85 bps. French Budget Minister Laurent Saint-Martin indicated the deficit risk is currently projected to exceed 6% of economic output, surpassing the previous estimate of 5.1%. He emphasized a focus on spending cuts and potentially tax increases to address the fiscal shortfall, which threatens France's financial market credibility. Italy's 10-year yield also fell by 2 bps to 3.46%, with the spread between Italian and German yields at 131 bps.

(With inputs from agencies.)