Euro Zone Bond Yields Climb Amid ECB Hawks

Euro zone government bond yields rose as investors scaled back bets on future rate cuts following the European Central Bank (ECB) meeting. Analysts noted the ECB raised its inflation forecasts, and Germany's persistent inflation driven by rising wages is a concern. Investors await upcoming U.S. employment data for further insights.

Euro zone government bond yields rose on Friday after the outcome of the European Central Bank policy meeting and further comments from policymakers led investors to scale back their bets on future rate cuts.

ECB rate-setters warned on Friday that the final stage of pushing inflation down to 2% could be tough. German inflation is proving stubborn, driven by a continued strong rise in wages, the Bundesbank said on Friday. Analysts highlighted that the ECB raised its inflation forecasts on Thursday and President Christine Lagarde did not provide any clues about the rate outlook.

Money markets priced in around 57 basis points (bps) of ECB monetary easing in 2024, which implies two rate cuts - including the one the ECB decided on Thursday - and around a 20% chance of a third move by year-end. The euro area's benchmark Bund yields were still on track to end the week with their biggest fall since mid-March as bets on monetary easing had increased in the days before the ECB policy decision on the back of U.S. data.

This week, investors increased their bets on future Federal Reserve rate cuts to 48 bps, from around 35 bps a week ago , while pricing in about 65 bps of rate cuts before the ECB meeting from less than 55 bps last Friday. Markets await the U.S. employment report for May later in the session after U.S. private payrolls increased less than expected in May and U.S. manufacturing activity slowed for a second straight month, pointing to more Fed rate cuts.

Germany's 10-year yield, the benchmark for the euro area, rose 4 bps to 2.58% and was on track for a weekly fall of 6.5 bps. It hit a 6-1/2-month high at 2.707% last Friday. "There was a (an ECB) comment that, given the fall in inflation so far, rates are more restrictive than they were last September, so (yesterday's) cut was to remove some of this restriction," said Nick Chatters, fixed income manager at Aegon Asset Management.

"So all in all, the cut was hawkish at the margin for the market, as there was no further guidance," he added. Analysts also flagged a divided governing council, as a few conservative ECB policymakers expressed regret on Thursday about signalling too explicitly that a rate cut was coming and some even said they might have otherwise voted for holding rates.

Germany's 2-year government bond yield, more sensitive to policy rate expectations, was up 3.5 bps at 3.05%. It hit 3.125% on Friday, its highest since mid-November. Italy's 10-year yield rose 5.5 bps to 3.92%.

The yield gap between Italian and German bonds , a gauge of the risk premium investors seek to hold bonds of the euro area's most indebted countries, widened to 133 bps. It hit a 15-month low at 115.4 bps in mid-March.