Euro Zone Bond Yields Spike to One-Month High Amid Inflation Data

Euro zone bond yields soared to their highest in over a month after inflation data from three German states showed an increase. Investors are awaiting national figures to gauge the European Central Bank's rate outlook, with a rate cut expected in June. Economists predict further cuts in September and December.

Euro zone bond yields surged to their highest in over a month on Wednesday after data showed inflation rising in three German states, but investors awaited the national figure for further clues on the European Central Bank's rate outlook. Inflation in three German states inched up in May, although price growth did slow in one state.

The inflation rate in North Rhine-Westphalia, Germany's most populous state, rose to 2.5% year-on-year in May from 2.3% in April. Economists will pay close attention to the national data due at 1200 GMT for clues on how much the ECB will cut rates this year. An ECB rate cut on June 6 appears certain, according to all 82 economists polled by Reuters, a majority of whom predicted two further reductions in September and December.

Germany publishes its figures before euro zone inflation and the U.S. personal consumption expenditure data which are due to be released on Friday. The German 10-year bond yield, the benchmark for the euro zone bloc, rose 4.8 basis points (bps) to 2.63% for its highest level since April 25.

Franziska Palmas, senior Europe economist at Capital Economics, said a weighted average of inflation figures for the six major German states suggests that German headline HICP will likely rise to 2.5% in May from 2.4% in April. A separate Reuters poll sees inflation in Germany rising to 2.7% in May.

"CPI inflation data published by the major German states this morning suggest that both German and euro-zone HICP inflation may come in a bit lower than expected," Palmas said. "The ECB has been paying particular attention to services inflation, but we don’t think the rise in May will deter it from cutting rates next week given that it is driven by temporary

factors. Nevertheless, a pause in July now seems more likely," she added. Money market traders are almost certain that the ECB will cut rates next week and are pricing in around 60 bps of monetary easing by year-end.

Italy's 10-year yield also touched a more than one-month high and was last up 4.2 bps at 3.94% while the gap between Italian and German bunds was at 130 bps. Germany's two-year bond yield, which is more sensitive to ECB rate expectations, was 1.9 bps higher at 3.07%.

The spread between U.S. 10-year Treasuries and German bunds narrowed by 1.6 points to 193 bps, having briefly surged to 196 bps, its highest since mid May earlier in the day.