Euro zone bond yields tick lower as economic activity contracts

Attention was now turning to the minutes from the Fed's June meeting, released at 1800 GMT on Wednesday, for insight into the future path of monetary policy. The Fed left the target range for the federal funds rate unchanged at 5-5.25% last month but projections showed policymakers saw two more 25 basis point rate hikes by the end of the year as inflation had been slower to decline and the economy fared better than expected.

Euro zone government bond yields edged lower on Wednesday after surveys indicated economic activity contracted in June, with focus turning to the minutes from the Federal Reserve's June meeting for insight on the path for interest rates.

HCOB's final Composite Purchasing Managers' Index (PMI), compiled by S&P Global slumped to 49.9, below the 50 mark separating growth from contraction for the first time since December. "In the grand scheme of things we're seeing increasing signals that the euro area is slowing down," said Jussi Hiljanen, chief strategist, EUR and USD rates at SEB.

"How this plays out for the European Central Bank remains to be seen. The summer data will decide how high interest rates will go." December 2023 ECB euro short-term rate (ESTR) forwards stand around 3.91%, implying market expectations for a deposit rate of about 4% by year-end. The rate is currently 3.5%.

ECB policymaker Joachim Nagel on Wednesday reiterated his view that interest rates would need to rise further, but added he was "wary" of calling a new era of high interest rates. Meanwhile, a poll from the ECB showed consumers cut their inflation expectations for the following 12 months to 3.9% in May from 4.1% the prior month, although consumers still expect inflation three years ahead to come in at 2.5%, above the ECB's 2% target.

"This is one of the indicators the ECB has been highlighting but it's clear a majority on the Governing Council agrees that core inflation has to decline for a few months before they can take a pause," SEB's Hiljanen said. Germany's 10-year yield, the euro zone's benchmark, was last down 2.5 basis points at 2.43%.

The policy-sensitive two-year yield was last down 2 bps at 3.269%, in close proximity to March's peak of 3.385%. A break above that level would take it to its highest since 2008. Attention was now turning to the minutes from the Fed's June meeting, released at 1800 GMT on Wednesday, for insight into the future path of monetary policy.

The Fed left the target range for the federal funds rate unchanged at 5-5.25% last month but projections showed policymakers saw two more 25 basis point rate hikes by the end of the year as inflation had been slower to decline and the economy fared better than expected. Markets, however, are pricing in a total of just 33 basis points of tightening by the Fed's November meeting.

"The minutes ... ought to reveal how much of a consensus there was among committee members at the time for a further tightening of the monetary reins in July," DZ Bank senior fixed income analyst Birgit Henseler said in a note. "One further key-rate hike prior to the summer recess appears to be virtually a foregone conclusion."

Italy's 10-year yield dropped 2 bps to 4.184%, keeping the gap between Italian and German 10-year yields little changed at around 174 bps, close to its widest level in almost four weeks reached on Tuesday.

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