Euro zone yields dropped on Tuesday after economic data revived fears of a marked economic slowdown, while investors got ready for a 50-basis point rate hike and possibly further hawkish guidance at this week’s European Central Bank policy meeting.
Data on Tuesday showed the euro zone eked out growth in the last quarter of 2023 but the overall picture remains weak, with a meager forecast for this year.
Inflation is still well above the ECB’s 2% target rate, leaving it with a delicate balancing act when it meets this week to set monetary policy.
“Markets expect the ECB to hike rates by 50 bps twice by March, while there is more uncertainty about what will happen then,” said Joost van Leenders, senior investment strategist at Van Lanschot Kempen.
Economic data from the United States, including slowing wage growth, a cooling housing market and falling consumer confidence, pushed Treasury yields lower. But a rise in consumer inflation expectations lifted yields off the day’s lows with all eyes on the Federal Reserve’s likely 25-bp hike on Wednesday.
Germany’s 10-year bond yield, the benchmark of the bloc, was last flat on the day at 2.298%. A month ago, it was around its highest since July 2011 at 2.57% on Dec. 30.
Yields have retreated by 26 bps this month, as investors have reassessed the likely timing of a peak in the ECB’s rate-tightening cycle.
ECB euro short-term rate (ESTR) forwards implied the deposit rate would peak at 3.5% this summer. Traders were betting that rates would peak at around 3.3% before Spain’s inflation numbers released on Monday.
ESTR forwards also implied a depo rate at 3.1% in May 2024.
The ESTR published by the ECB reflects the wholesale euro unsecured overnight borrowing costs of banks in the euro area. It is usually around 10 bps below the deposit rate.
Spain’s inflation was at 5.8% versus 5.5% in December and above the 4.7% expected by analysts polled by Reuters.
Economists polled by Reuters expected the ECB to deliver a 50 bps rate hike at its policy meeting on Thursday and to stop when the deposit rate reaches 3.25% next quarter.
France’s inflation was 7.0% in January, up from 6.7% in December, while euro area numbers are due on Wednesday.
Crucial euro zone inflation data will include only an estimate for Germany after the bloc’s biggest country delayed the release of its own figures, Eurostat said on Monday.
“This makes the guesswork for tomorrow’s HICP (harmonized index of consumer prices) not easier,” said Christopher Rieger, head of rates and credit research at Commerzbank.
“If anything, the missing German numbers could mean downside risk to headline and upside risk to core inflation in the HICP Eurostat estimates,” he added.
Italy’s 10-year yield fell 3 bps to 4.28%, with the gap between Italian and German 10-year yields – a gauge of the risk premium for the government bonds of Southern Europe’s highly indebted countries – at 197 bps. (Reporting by Stefano Rebaudo; additional reporting by Susan Mathew; editing by Jason Neely, Chizu Nomiyama and Barbara Lewis)