Euro zone yields rise as markets reduce bets on April rate cut

Germany’s 10-year government bond yield, the benchmark for the euro area, was last up 2 bps to 2.376% after earlier hitting 2.39%, its highest level since the start of December. Markets discounted a 47% chance of a first 25 bps ECB rate cut in April, after pricing it in fully at the end of January.

Euro area bond yields hit multi-week highs on Friday while money markets trimmed bets on European Central Bank rate cuts, pricing in a less than 50% chance of a first move in April and around 115 basis points of easing in 2024. Germany's 10-year government bond yield, the benchmark for the euro area, was last up 2 bps to 2.376% after earlier hitting 2.39%, its highest level since the start of December.

Markets discounted a 47% chance of a first 25 bps ECB rate cut in April, after pricing it in fully at the end of January. The repricing began late last Friday in response to strong U.S. economic data and rate-setters saying central banks must be cautious before reducing rates.

The ECB needs more evidence that inflation is heading back to its 2% target before it can cut interest rates, even if confidence is mounting that price pressures are easing, two policymakers said on Thursday. Thursday's U.S. figures confirmed underlying labour market strength, adding to expectations that the Federal Reserve will take time to ease.

Yields extended their rise on Friday after data showed U.S. monthly consumer prices rose less than initially estimated in December but slightly more than reported in October and November. Germany's 2-year bond yield, which is sensitive to interest rate expectations, was last up 5 bps at 2.716%, around its highest level since early December.

Jon Jonsson, senior fixed income portfolio manager at Neuberger Berman, said the rise in shorter-term yields was largely due to "a reassessment of cut expectations as labour markets are proving more resilient". ECB euro-short-term rate (ESTR) forwards priced in around 115 bps of rate cuts by year-end, from around 140 bps last week, before U.S. jobs data.

The ESTR has been 10 bps below the deposit facility rate, which the ECB set at 4%. Italy's 10-year government bond yield was up 3 bps at 3.969%, with the gap between Italian and German 10-year yields slightly wider at 157 bps.

Analysts mentioned Thursday's comments by ECB hawk Robert Holzmann, in an interview with Frankfurter Allgemeine, that "there is a certain chance there will be no rate cut at all this year, or only at the very end of the year". Market participants label as hawks central bank officials who advocate a tight monetary policy to control inflation, while doves focus more on economic growth and the labour market.

"The hawkish reassessment of ECB cut pricing for the first half is U.S.-led, but the positive turn in the euro area Citi Economic Surprise Index (CESI) and the cut-off for the March staff projections suggest it may have further to run," Citi said in a note to clients. Citi suggested the cut-off for the ECB economic projections may have been Wednesday, and that wage figures, which are crucial for a possible central bank decision on rates, will be missing.

CESI measures the sum of the differences between official economic data and market forecasts.