Euro area government bond yields drop after US, UK data

Euro zone government bond yields eased on Thursday after data showed U.S. retail sales fell more than expected last month while the labour market remained tight, reinforcing bets of Federal Reserve interest rate cuts later this year.

Euro zone government bond yields eased on Thursday after data showed U.S. retail sales fell more than expected last month while the labour market remained tight, reinforcing bets of Federal Reserve interest rate cuts later this year. In the UK, figures showed Britain's economy entered a recession in the second half of 2023, driving British yields down and affecting other fixed-income markets.

U.S. retail sales dropped 0.8% last month, much more than expected by economists polled by Reuters, who had forecast a 0.1% drop. A separate U.S. report showed initial claims for state unemployment benefits fell 8,000 to a seasonally adjusted 212,000 for the week ended Feb. 10.

"While today’s report disappointed forecasters, it comes after a string of upside surprises. Given how restrictive monetary policy is, the level of consumption is still very strong and the labour market remains fairly tight," said Ali Jaffery, an economist at CIBC Capital Markets. "The Fed will be focused on the latter as it decides when to start dialling back on policy. We expect that to begin in the second half of this year."

Analysts said euro area government bonds remained highly sensitive to economic figures as central banks focus on data for monetary policy direction. Euro zone inflation is heading back towards the 2% target but the European Central Bank needs more confirmation before it can cut rates, two influential policymakers said on Thursday.

ECB chief economist Philip Lane said in a speech on Thursday the bank's past rate hikes are still unfolding. In the meantime, the European Commission cut on Thursday its euro zone GDP growth forecast for 2024.

Germany's 10-year yield, the benchmark for the euro area, was down 1.6 basis points (bps) at 2.33%, after falling to a eight-day low earlier. It hit 2.415% on Tuesday, its highest level since Dec. 1.

Bund yields have recently risen as rate-setters on both sides of the Atlantic said central banks must be cautious in easing monetary policy, leading investors to scale back bets on rate cuts in the euro zone in 2024 up to around 105 bps , from 145 bps at the end of January. It last discounted 115 bps. UK FALLS INTO RECESSION

British 10-year yields dropped 2.9 bps to 4.02% after data showing Britain's gross domestic product (GDP) shrank by a worse-than-expected 0.3% in the three months to December. "For the Monetary Policy Committee (MPC), this is a meaningful miss on GDP," said Sanjay Raja, UK economist at Deutsche Bank.

"While the Bank of England's focus will likely remain on price data, the bigger drop in output and the politics of being in a technical recession will no doubt become uncomfortable, especially with Bank Rate at highly restrictive levels." Adding further pressure on the global economy, Japan also unexpectedly slipped into a recession at the end of last year.

Italy's 10-year yield, the benchmark for the euro area's periphery, dropped 3 bps to 3.83%, with the gap between Italian and German 10-year yields at 149.55 bps. UniCredit flagged that the BTP-Bund correlation has increased to 91% in the last three months, "signalling a smaller impact coming from Italy-specific factors."

"We think that Italian paper remains well supported in light of more appealing carry returns than on other euro zone curves," UniCredit said in a research note.