Euro zone bond yields diverge ahead of inflation data

A brutal selloff in European government bond markets left traders on ​Friday favouring safe-haven German debt over weaker countries such ​as France ahead of euro zone inflation data, ‌albeit ​with far less volatility than the previous day.

Yields had diverged sharply on Thursday, especially among shorter-dated bonds. German 2-year bond yields dropped almost 14 basis points, their biggest daily fall since April, ‌and the Dutch 2-year yield fell around 13 bps, while those on French and Italian 2-year yields jumped. German and Dutch government bonds are typically seen as safe havens, while others such as French and Italian bonds are regarded as more risky, given the size of those ‌countries' debt burdens relative to their economies. Government bonds around the world have been under pressure recently amid debt and fiscal concerns, ‌high energy prices and worries about inflation.

The divergence continued on Friday, but less sharply. German 2-year bond yields were last down by 5.4 bps to 3.0005%, while French 2-year yields were last less than one basis point lower at 3.6848% and Italian 2-year yields were steady at 3.6178%. Shorter-dated government bond yields are generally more sensitive ⁠to ​interest rate expectations. Money markets on Thursday ⁠and Friday pared back pricing for further interest rate hikes from the European Central Bank and were last no longer fully pricing in another policy increase ⁠from the ECB.

Euro zone inflation data is due later in the day and will be closely watched by investors for clues about what the ​ECB's interest rate path ahead may look like. Inflation is expected to have picked up across the region again in ⁠September, fuelled by higher energy prices, but traders will also be assessing whether the data sheds any light on possible second-round inflation effects starting to come through. 10-year government bond ⁠yields ​also diverged again on Friday. German 10-year bond yields were last down 5.4 bps at 3.4651%. Meanwhile, French 10-year yields were steady at 4.9299%. The spread between the two was last near 146 bps, its widest since 2012.

French bonds have been under especially ⁠strong pressure as high debt levels and emerging political risks ahead of a 2027 presidential election have added to factors weighing on government ⁠bonds more broadly, such as ⁠expectations for higher policy rates. France on Thursday presented its 2027 budget bill, seeking to enact unpopular belt-tightening measures to lower its deficit.

Italy's 10-year government bond yield was last down by 1.5 bps to 4.6989%. ‌The spread between Germany's ‌and Italy's 10-year bond yields was last near 120 bps.