Euro zone bonds steady, back in 'wait and see' mode after recent selloff

Euro zone bond yields dipped a touch on Wednesday after data showing German industrial production fell more than expected in December, but borrowing costs on both sides of the Atlantic largely continued to stabilise after their recent sharp moves. Germany's 10-year yield, the benchmark for the euro zone, dropped around 2 basis points (bps) to 2.28%.

Euro zone bond yields dipped a touch on Wednesday after data showing German industrial production fell more than expected in December, but borrowing costs on both sides of the Atlantic largely continued to stabilise after their recent sharp moves.

Germany's 10-year yield, the benchmark for the euro zone, dropped around 2 basis points (bps) to 2.28%. In the mix on Wednesday was a larger-than-expected fall in German industrial production in December, the latest sign of weakness in the bloc's largest economy, and remarks from European Central Bank board member Isabel Schnabel that the ECB must be patient with cutting interest rates as inflation could flare up again.

Neither German economic weakness nor the views of ECB hawks like Schnabel are new to markets, but they illustrate the dilemma for rate setters as they weigh sluggish economic growth against the fight against inflation in their attempts to decide when to begin interest rate cuts. "We are in a bit of a wait-and-see mode right now. I believe that duration will likely range trade in the coming weeks as we need more of a catalyst to see a rally, but equally I don't see a massive sell off from here," said Emmanouil Karimalis, European rates strategist at UBS.

'Duration' conventionally refers to 10-year bonds. "This will depend on communication and data, given that all the central banks are in data dependent mode," Karimalis added.

While conservatives or hawks in central bank-speak have pushed back on bets for an ECB rate cut in April, a move around mid-year appears uncontroversial. Current market pricing indicates roughly a two thirds chance the ECB will begin cutting rates in April with a 25 basis point move. It shows a larger chance of 50 bps of cuts by June.

Bond markets are currently very sensitive to changes in expectations of central bank's interest rate path. Yields in Europe rose sharply on Friday, and again Monday dragged along by soaring yields on all-important U.S. Treasuries after U.S. jobs data handily beat expectations, causing markets to largely give up on expectations the Federal Reserve will be cutting by March.

The 18 basis points move in the German benchmark yield was its biggest two-day rise since March 2023. Moves elsewhere in Europe were also fairly muted on Wednesday. Italy's 10-year yield was down around 1 basis point at 3.85% leaving the closely watched spread between German and Italian 10-year yields at 155 bps.

Germany's two-year yield was around 1 bp lower at 2.60% and Italy's two-year yield was flat at 3.24%.

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