Euro Zone Bond Yields Drop Amid Inflation Decline

Euro zone bond yields dropped as inflation in the bloc fell below the ECB's 2% target, increasing bets on an October rate cut. German bund yields fell due to geopolitical tensions, while France and Italy also saw declines. The ECB is considering interest rate cuts amid the inflation slowdown.

Euro zone bond yields experienced a drop on Tuesday as data revealed that inflation in the bloc had declined below the European Central Bank's (ECB) target of 2% in September, fueling expectations of an interest rate cut in October. Geopolitical tensions further contributed to the fall in German bund yields, while French bond yields also declined after the government announced targeted tax rises and spending cuts to address the budget deficit.

According to the latest data, euro zone inflation eased to 1.8% year-on-year in September, the first drop below 2% since mid-2021, from 2.2% in August. Germany's 10-year bond yield, a benchmark for the bloc, dropped to a low of 2.011%, its lowest since January, and last stood at 2.038%, down 9.5 basis points. Yields inversely correlate with prices.

Jussi Hiljanen, SEB's head of European rates strategy, noted, 'Interest rate expectations have seen a significant shift over the past week, with an October rate cut now largely anticipated.' Traders now see a more than 90% chance of a 25 bp cut from the ECB in October. The ECB has already cut rates by 25 bps in June and September to 3.5%.

Finnish ECB policymaker Olli Rehn stated that the inflation slowdown justifies an interest rate cut at the upcoming October meeting. ECB President Christine Lagarde mentioned that the ECB would consider the inflation drop. Italy's 10-year yield fell 10 bps to 3.364%, and the gap between Italian and German yields narrowed to 132 bps.

France's 10-year bond yield saw its largest one-day drop since May, falling 11 bps to 2.813%, supported by reports of potential tax hikes ranging from 15 to 18 billion euros. The spread between French and German 10-year yields narrowed by 2 bps to 77 bps.

Markets remain vigilant to geopolitical developments, particularly in the Middle East, with U.S. officials reporting potential Iranian ballistic missile threats against Israel. Michael Brown, senior research strategist at Pepperstone, commented, 'The market is demonstrating heightened sensitivity to geopolitical news, triggering a risk-off move.'

(With inputs from agencies.)