German yields dip after PMI data, still close to multi-year highs

Germany's 10-year government bond yield, the benchmark for the euro area, dropped one basis point (bp) to 2.74% after hitting 2.779% the day before, its highest level since July 2011. Money markets slightly scaled back their expectations for an additional rate hike by January 2024 to around 25% from 30% on Thursday.

German government bond yields edged lower on Friday but were still close to multi-year highs, after data confirmed a contraction in the euro area's economic activity.

Euro area PMI, seen as a gauge of economic health, rose to 47.1 in September from August's 33-month low of 46.7, but still lingering below the 50-mark separating growth from decline.

The HCOB France flash purchasing managers index (PMI) for the services sector fell to a 34-month low in September, while the German PMI rose to 46.2 but missed economists' forecasts. "PMI data were mixed, and overall, the euro area did a bit better than expected," said Joost van Leenders, senior investment strategist at Van Lanschot Kempen.

"They were still consistent with expectations for stagnation or negative growth, which supports forecasts that the central bank is done with rate hikes," he added. Germany's 10-year government bond yield, the benchmark for the euro area, dropped one basis point (bp) to 2.74% after hitting 2.779% the day before, its highest level since July 2011.

Money markets slightly scaled back their expectations for an additional rate hike by January 2024 to around 25% from 30% on Thursday. European Central Bank policymakers have recently warned of risks of an additional rate hike.

Euro zone inflation is stubbornly high with upside risks, so the ECB's next move could still be a rate increase before cuts come onto the agenda, several policymakers said on Thursday. ECB policy dove Philip Lane said on Friday companies were finally absorbing wage pressures, and the labour market has started to soften, suggesting inflation pressures from employee pay rises are finally subsiding.

Fixed-income markets reacted moderately to the Federal Reserve and the Bank of England (BoE), which kept rates unchanged, reiterating that more hikes could come. Policy-sensitive German 2-year yield fell 2 bps to 3.24%. It hit its highest level since October 2008 at 3.393% in early July.

The Bank of Japan (BoJ) maintained ultra-low interest rates and its pledge to keep supporting the economy until inflation firmly reaches its 2% target, suggesting it was in no rush to phase out its massive stimulus programme. Japanese investors hold large amounts of foreign debt, and some analysts worried they might reduce their exposure to Europe if domestic assets become more attractive with a BoJ tightening of monetary policy.

Italy's 10-year yield, the benchmark for the euro area's periphery, was one bp lower at 4.54%. The spread between Italian and German 10-year yields – a gauge of market sentiment towards the euro area's most indebted countries – was at 179 bps after recently hitting its widest level in three-and-a-half months at 180.9 bps.

Spain's gross domestic product grew 0.5% in the second quarter, confirming a faster and more robust economic rebound.