Bund yield dips slightly, set for biggest weekly increase in three months

In the bigger picture, the German 10-year yield, which moves inversely to the bond's price, has risen around 40 bps since its late December lows, as investors reassess expectations that central bank rate cuts on both sides of the Atlantic will 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.

Euro zone bond yields edged down from 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 3 basis points lower at 2.28%, though set for a weekly gain of 14 basis points (bps), which would be its biggest weekly move since October.

Friday's move lower in the German yield echoed a fall in British gilt yields, which dropped around 5 bps after data showed a slump in UK retail sales. In the bigger picture, the German 10-year yield, which moves inversely to the bond's price, has risen around 40 bps since its late December lows, as investors reassess expectations that central bank rate cuts on both sides of the Atlantic will 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 in terms of public appearances 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 7 bps at 3.84%, moving off Wednesday's one-month high of 3.938%. The spread between Germany and Italy's 10-year yields reached 154.7 bps, its narrowest in nearly a month. Germany's 2 year yield was flat at 2.68%, and Italy's dropped 3 bps to 3.2%.