Euro zone yields on track for weekly fall but focus on U.S. data

Euro zone government bond yields were set for a weekly fall after inflation data failed to settle the debate on the European Central Bank's September rate decision, and as investors assessed a less hawkish stance by ratesetter Isabel Schnabel.

Euro zone government bond yields were set for a weekly fall after inflation data failed to settle the debate on the European Central Bank's September rate decision, and as investors assessed a less hawkish stance by ratesetter Isabel Schnabel. Traders expect a quiet morning with bond prices, which move inversely with yields, in a narrow range ahead of U.S. job figures, which might provide a clearer direction to the market. Recent data has reinforced expectations the Federal Reserve will hold interest rates steady this month.

"Schnabel's decision to sit on the fence for September feels significant given her last speech in June called for erring on the side of doing too much," Citi analysts said in a note. "The speech argued for a genuine meeting-by-meeting approach amidst the uncertainty," they added.

Germany's 10-year government bond yield, the benchmark for the euro area, rose one basis point (bp) to 2.48%. It has dropped 7.5 bps during the week and is currently set for its biggest weekly fall since mid-July. "ECB board member Schnabel seems to have abandoned some of her hawkish views," said Christoph Rieger, head of rates and credit research at Commerzbank.

The policy-sensitive 2-year yield was down 1.5 bps at 2.96%, and it is currently set to end the week down 6.5 bps, in its biggest fall since mid-August. "The market went for the dovish interpretation, though we think that some of Schnabel's assessments still point to her hawkish nature," said Benjamin Schroeder, senior rates strategist at ING.

"For instance, she pointed out that under certain circumstances, a hike could also 'insure against the continued elevated risk of inflation remaining above (the ECB's) target for too long'." ECB Vice President Luis de Guindos and policymaker Francois Villeroy de Galhau said the decision on whether to further tighten monetary policy was still open for debate.

ECB's Boris Vujcic, seen as a hawk, underlined that a resilient labour market continues to produce quick wage growth. Money markets are pricing an around 30% chance of a 25 bps hike this month, from 60% right after the release of inflation data from the German state North Rhine-Westphalia on Wednesday.

Euro zone inflation proved unexpectedly stubborn last month, although price pressures for underlying goods eased. Analysts underlined that the ECB is watching service prices and that this component is a proxy for inflation momentum.

"The main uncertainty moving forward will be how fast and far services inflation rates drop as the weakening growth momentum will be counteracted by persistently elevated wage inflation," said Marc de Muizon, senior economist at Deutsche Bank Research.