Euro zone yields drop, markets price over 100 bps of rate cuts in 2024 after ECB statement

ECB euro short-term rate (ESTR) forwards priced in 102 bps of rate cuts in 2024, from 92 bps before the ECB statement. Investors will scrutinise Lagarde's comments and new economic projections, which are expected to downgrade inflation and growth forecasts for this year.

Euro zone government bond yields extended their fall on Thursday after the European Central Bank revised down its inflation projections, opening the way for rate cuts later this year. The ECB estimates for inflation excluding energy and food have also been revised down, and average 2.6% for 2024, 2.1% for 2025 and 2.0% for 2026.

Bond yields have risen in 2024 - with the German 10-year yield up around 30 bps - as investors have reined in expectations for rapid and steep interest rate cuts, with economic data coming in stronger than expected and central bankers sticking to a tough line on inflation. Germany's 10-year bond yield, the benchmark borrowing cost for the euro zone, was last down 7 basis points (bps) at 2.26%.

"New downward revisions of inflation and growth forecasts in today's ECB statement support expectations for monetary policy easing," said Massimiliano Maxia, senior fixed-income product specialist at Allianz Global Investors. ECB euro short-term rate (ESTR) forwards priced in 102 bps of rate cuts in 2024, from 92 bps before the ECB statement.

Investors will scrutinise Lagarde's comments and new economic projections, which are expected to downgrade inflation and growth forecasts for this year. Analysts said the ECB was currently in a holding pattern, awaiting further information on inflation before commencing their soft landing.

Italy's 10-year bond yield was 9 bps lower at 3.57%, with the spread over Germany's 10-year yield -- a gauge of the risk premium investors ask to hold bonds of the euro area's most indebted countries -- hitting 128.9 bps, its lowest level since January 2022. Yields cooled on Wednesday as investors took comfort from U.S. Federal Reserve chair Jerome Powell's balanced comments on inflation and interest rates. Powell said he still expected rate cuts in the coming months if inflation continued to drop.

Market pricing suggests investors expect the Fed to start cutting rates in June, with around 90 bps of cuts expected from both central banks this year. Germany's 2-year bond yield, which is sensitive to ECB rate expectations, was down 9.5 bps on Thursday at 2.78%.