Euro zone yields edge lower tracking oil, US Treasuries, before ECB meeting

Euro zone government bond yields edged lower on Thursday, tracking ​moves in oil prices and US borrowing costs, with investors ​sticking to the sidelines before the results of ‌the ​latest European Central Bank policy meeting later in the day.

Separately, ECB President Christine Lagarde announced she will step down in February, ending months of speculation about her future at a ‌complex juncture for Europe and the central bank. Brent crude futures fell about 1%, after media reports said US Vice President JD Vance sought to revive peace negotiations by sending a letter to Iran's Supreme National Security Council chief Mohsen Rezaei.

Investors expect the ECB to provide no ‌guidance on the rate outlook after its policy meeting. "We expect her (Lagarde) to keep the meeting-by-meeting language while retaining a tightening bias, ‌but any emphasis on tighter financial conditions could see December pricing tested," Evelyne Gomez-Liechti, multi-asset strategist at Mizuho, said.

Traders scaled back their bets on future ECB rate hikes in early October, which have remained quite stable since then. Euro short-term rate (ESTR) forwards implied the depo rate would rise to 2.71% by December from the ⁠current ​2.50%, and then to 3.24% by ⁠late 2027. "By the time we come to the March meeting, either oil prices would have started to come lower and there would be no need ⁠for a hike, or if oil prices remain elevated the focus would need to shift towards the growth impact which would also make any ​hikes difficult," Mohit Kumar, an economist at Jefferies, said. Jefferies expects a hike in December.

The German 2-year government bond yield, ⁠more sensitive to policy rate expectations, declined 1.5 basis points (bps) to 3.08%, after US borrowing costs fell. The Federal Reserve held interest rates steady on Wednesday as expected, ⁠opting ​to delay any changes to borrowing costs until after next week's US midterm elections.

Germany’s 10-year government bond yield, the euro area benchmark, was down 0.5 bps at 3.37%. The yield gap between French OAT bonds and Bunds was roughly unchanged at 154 ⁠bps, after hitting 177.70 last week, the highest level since November 2011.

"Despite mounting problems, France is not yet close to a full-blown ⁠crisis," Holger Schmieding, chief economist ⁠at Berenberg, said. "In case of a dramatically worsening crisis, the ECB could use its tools such as liquidity injections into short-term funding markets to prevent them from seizing up and/or deploy its 'Transmission Protection Instrument (TPI)' ‌to shield other countries ‌such as Italy from contagion risks," he added.