German 10-year yield falls, German-Italian spread at 2-year low

Meanwhile, Italy's 10-year bond yield, the benchmark for the euro zone's periphery, was last down 8 bps to 3.743%, pushing the gap between German and Italian 10-year yields to around 135 bps, its tightest since February 2022. SEB's Hiljanen said the possible start of a cutting cycle, improving global risk appetite and the decline in long-end yields since October was adding to the positive sentiment in Italian bonds.

Germany's 10-year bond yield slipped on Tuesday while the spread between Italian and German 10-year yields was at its tightest since February 2022 as markets braced for pivotal risk events including the European Central Bank's policy announcement. The ECB is seen leaving its main policy rates unchanged on Thursday, at their record high, with markets watching for clues from President Christine Lagarde on when interest rate cuts might begin.

Stickier inflation in Europe and the United States and a more robust global growth outlook have seen markets scale back expectations for easing this year, with the timing of the first interest rate cuts also pushed back. Money market traders now expect ECB policy easing to begin in June, with around 4 basis points (bps) of cuts priced in for April, implying just a 15% chance of lower interest rates then.

At the start of the year, an April rate cut was almost fully priced in. Traders are also pricing in only 90 bps of easing this year, down from around 150 bps, or approximately six quarter-point cuts, expected in January.

"Given the massive repricing that we've recently seen, it would take quite a hawkish rhetoric from the ECB to push markets further in the hawkish direction," said Jussi Hiljanen, head of rates strategy at lender SEB. "I think they will essentially repeat the message from previous meetings that rate hikes are over and that the summer is probably the right time to begin cutting rates."

Germany's 10-year bond yield, the euro area's benchmark, was last down 3 bps at 2.365%. The yield hit its highest since November last Thursday at 2.513%. The two-year yield, which is sensitive to changes in policy rate expectations, was last down 1.5 bps at 2.8816%.

Markets will digest Britain's Spring Budget on Wednesday, the first leg of Federal Reserve Chair Jerome Powell's semi-annual testimony to Congress, and a raft of data, including the U.S. payrolls report on Friday. Meanwhile, Italy's 10-year bond yield, the benchmark for the euro zone's periphery, was last down 8 bps to 3.743%, pushing the gap between German and Italian 10-year yields to around 135 bps, its tightest since February 2022.

SEB's Hiljanen said the possible start of a cutting cycle, improving global risk appetite and the decline in long-end yields since October was adding to the positive sentiment in Italian bonds. "The lower yields become in Italy, the more sustainable becomes the debt situation," Hiljanen said.