Bund yield set for weekly rise as markets reduce bets on rate cuts

"The rally has been Fed-led, and the ECB meeting in December guides towards a cut mid-2024 at the earliest," they added. Germany's 10-year government bond yield, the benchmark for the euro area, rose 6.5 bps to 2.17%, a fresh 3-week high.

The German Bund yield was on track to record its biggest weekly rise since mid-October after robust economic data on both sides of the Atlantic led investors to unwind some of their bets on European Central Bank rate cuts for 2024. Markets await U.S. job data later in the session, which could affect expectations for the Federal Reserve's policy path.

Euro zone inflation surged last month, easing financial markets pressure on the ECB to start cutting rates. December 2024 ECB euro short-term rate (ESTR) forwards rose to 2.46% - implying 144 bps of cuts in the ECB deposit facility rate this year - from 2.22% early on Thursday that had implied 168 bps of cuts. The depo rate is at 4%, 10 bps above the ESTR.

"We still think ECB pricing (of future rate cuts) has overshot," Citi analysts said in a research note. "The rally has been Fed-led, and the ECB meeting in December guides towards a cut mid-2024 at the earliest," they added.

Germany's 10-year government bond yield, the benchmark for the euro area, rose 6.5 bps to 2.17%, a fresh 3-week high. It was on track to end the week 14 bps higher. Jack Allen-Reynolds, deputy chief euro-zone economist at Capital Economics, said he expected a rate cut "in or around" April.

"December’s jump in headline inflation was widely anticipated and entirely due to a base-effects driven increase in energy inflation," he said. German retail sales fell more than expected in November, decreasing by 2.5% compared with the previous month.

U.S. Treasury yields were up in London trade, with the benchmark 10-year yield hovering around 4%, after rising the day before as labour market data tempered expectations of an interest rate cut by the Fed in March. Investors focused on the Labor Department's employment report for December after the weekly figures were released on Thursday. Nonfarm payrolls likely increased by 170,000 jobs in December, according to a Reuters survey of economists, after rising by 199,000 jobs in November.

Italy's 10-year government bond yield, the benchmark for the euro area periphery, rose 7.5 bps to 3.86%, with the gap between Italian and German yields at 167.5 bps after dropping below 160 bps last week. Expectations for aggressive policy rate cuts in 2024, a slower-than-expected ECB plan to reduce Pandemic Emergency Purchase Programme (PEPP) reinvestment, and a European Union stability pact allowing more time to cut public debt supported demand in Italian government bonds late last year.