Euro Zone Bond Yields Dip Amid Easing Recession Concerns

Euro zone bond yields experienced a slight decline following data that revealed continued weak manufacturing activity in May. The market is keenly anticipating the European Central Bank's likely rate cut on Thursday, which could provide further economic insights. Analysts note an easing recession and ongoing debates on future rate cuts.

Euro zone bond yields fell slightly on Monday after data showed the bloc's factory activity remained weak in May, but the moves were muted as traders awaited a likely European Central Bank rate cut on Thursday. Germany's 10-year bond yield, the benchmark for the euro zone bloc, fell 2 basis points (bps) to 2.626%.

Final readings of survey-based gauges of Europe's manufacturing sector showed activity remained below the mark denoting growth for a 23rd month. The purchasing managers' index surveys also came in slightly lower than preliminary readings, although the downturn was still moderated compared to April.

"Overall, these data suggest that conditions in manufacturing remained difficult midway through Q2," said Claus Vistesen, chief euro zone economist at Pantheon Macroeconomics. "But they also clearly signal that the recession...is now easing."

Italy's 10-year yield was down 4 bps at 3.92%, and the gap between Italian and German yields narrowed to 129 bps. The market's focus this week is on the ECB's interest rate decision on Thursday, when it is all but certain to cut rates to 3.75%, from the current record high of 4%.

Investors will be looking out for any hints about when the next reduction might come, with some on the ECB's Governing Council pushing back against the idea of a July cut. Data last week showed that euro zone inflation was stronger than expected in May. Germany's two-year bond yield, which is more sensitive to European Central Bank rate expectations, was down 1 bp at 3.069%.

"While there is a consensus on this first rate cut, the pace of future cuts is already subject to lively debate within the Council," said Franck Dixmier, global chief investment officer for fixed income at Allianz Global Investors, in emailed comments. "Future inflation data is likely to be volatile, and the ECB is likely to caution that it is sticking to its gradual approach to cutting rates."

French bonds showed little notable reaction to ratings agency S&P downgrading the country's credit rating late on Friday. Just before the EU's parliamentary elections, S&P cut France's rating to "AA-" from "AA", saying higher than expected deficits would push up debt in the euro zone's second-biggest economy.

France's 10-year bond yield was down 3 bps at 3.108%, broadly in line with the move in other euro zone country bonds. The spread between U.S. 10-year Treasury and German bund yields held steady at 185 bps.