Bund yield steady, set for biggest weekly increase in six months

Euro zone bond yields paused near one-month highs on Friday, having been supported this year by reassessments of earlier bets on imminent central bank rate cuts, and as focus shifts to next week's European Central Bank (ECB) meeting. Germany's 10-year yield, the benchmark for the currency bloc, was last flat at 2.31%, though set for a weekly gain of 17 basis points (bps), which would be its biggest weekly move since July.

The yield, which moves inversely to the bond's price, is up around 40 bps since its late December lows, as investors reassessed expectations that central bank rate cuts on both sides of the Atlantic would come as soon as March due to push back from policymakers and resilient economic data, particularly in the U.S. Market pricing now reflects roughly an 80% chance of the ECB cutting rates in April.

In late December, a March cut was all but priced in on the back of data showing slowing inflation in both Europe and the U.S. and supported by the release of Fed forecasts of meaningful rate cuts this year. ECB policy makers were out in force this week, and the broad thrust was that there was no rush to cut rates, though there was variety in the vehemence of their messaging.

"Markets are getting ahead of themselves," Dutch central bank chief Klaas Knot said on Wednesday. "We are optimistic that we have a credible prospect of a return of inflation to 2% in 2025, but a lot still needs to go well for that to happen." Data for December showed euro zone inflation jumped to 2.9% from 2.4% in November, but the increase was more due to technical factors, and economists said it would not disrupt them broadly moving lower towards the ECB's 2% target.

The ECB has its next meeting next Thursday, and policymakers are now forbidden from speaking publicly about their views on rates ahead of that meeting, though analysts think a change of tone is becoming due. "Inflation is going to be very close to target in Europe, so the same way we saw a change in tone from the Fed in December, that's going to come for the ECB. Maybe it's not going to happen in January, but then it will be in March," said Samy Chaar, chief economist at Lombard Odier.

"If they persist in their hawkish rhetoric they are no longer aligned with the economy of Europe." Italy's 10-year yield, the benchmark for the European periphery, was down 3 bps at 3.90%, just off Wednesday's one-month high of 3.938%. The spread between Germany and Italy's 10-year yields was at 156.9 bps, towards the narrow end of its recent range.

Shorter dated yields were also broadly steady. Germany's 2 year yield was up 1 bp at 2.70%, and Italy's flat at 3.23%.