Higher Spanish inflation kicks euro zone bond yields off two-week lows

It dropped to as low as 2.198% in early trading, its lowest in two weeks, but moved higher after data showed Spain's European-Union harmonised prices rose 3.5% in the 12 months through January driven by higher electricity costs. That was up from a 3.3% increase in the period through December, and above expectations of analysts polled by Reuters.

Higher-than-expected Spanish inflation data jolted euro zone bond yields off two-week lows plumbed earlier on Tuesday on the back of market expectations of a European Central Bank rate cut as soon as April. Traders were digesting German and French GDP data released on Tuesday that showed the euro zone's largest economy shrank 0.3% in the fourth quarter and its second-largest economy failed to grow, both in line with analyst expectations.

Germany's 10-year bond yield was last up 4 basis points (bps) on the day at 2.25%. It dropped to as low as 2.198% in early trading, its lowest in two weeks, but moved higher after data showed Spain's European-Union harmonised prices rose 3.5% in the 12 months through January driven by higher electricity costs.

That was up from a 3.3% increase in the period through December, and above expectations of analysts polled by Reuters. It raises concern that German and French inflation figures on Wednesday and the euro zone data on Thursday could also tick up and confound expectations that rate cuts were on their way, though the broad trend in recent months has shown that inflation is slowing.

"These spikes are obviously putting doubt on the forward monetary policy, but the European Union will look at the whole situation and the reality is that the economy continues to be sluggish and at a certain point with inflation close enough to their target they start to switch their focus," said Althea Spinozzi, head of fixed income strategy at Saxo Bank. Benchmark U.S. 10-year Treasury yields hovered near two week lows as investors weighed unexpected strength in the job market.

In the euro area's primary markets, Germany was set to raise 5 billion euros ($5.4 billion) from a new 30-year bond on Tuesday against a record investor demand of more than 74 billion euros, according to memos from three lead managers seen by Reuters. Euro zone yields have moved sharply in recent months together with swings in rate expectation. Market pricing points to a 90% chance of the first ECB rate cut as soon as April, though this was fully priced in on Monday.

Germany's 10-year bund yield fell from above 3% in early October to below 2% in late December as markets bet central banks would be cutting rates as soon as March. But it rose in January as these bets were pushed back and dipped again as investors took away the message from last week's ECB meeting that cuts were not too far off. Germany's two-year yield, most sensitive to moves in rate expectations, was last 5 bps higher at 2.53%, having hit a three-week low on Monday.

Italy's 10-year yield was 7.5 bps higher at 3.82%, and the spread between Italian and German 10-year yields was a touch wider on the day at 152 bps but still around its tightest in 22 months. There is plenty more news for bond markets to come this week with rate decisions by the Federal Reserve and Bank of England, as well as U.S. payrolls data.