Euro zone yields edge higher as investors weigh rate outlook

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Euro zone government bond yields edged higher on Monday as investors balanced expectations for a slowdown in central banks’ monetary tightening path against more strong U.S. data which fueled inflation fears.

Analysts said the focus would be on comments from European Central Bank officials in the next few days, which might fine-tune the market view on rates. The ECB pre-meeting blackout period starts on Thursday.

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Germany’s 10-year government bond yield, the benchmark of the bloc, was up 2 basis points (bps) at 1.877%, reversing an earlier fall. It hit its lowest since Sept. 19 on Friday at 1.76% before closing at around 1.85%.

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Money markets price in a rate hike of around 50 bps at the ECB’s Dec. 15 policy meeting.

U.S. employers hired more workers than expected in November and increased wages, shrugging off worries of a recession.

“The reaction to nonfarm payrolls on Friday is quite indicative of how strong demand currently is and suggests that the bar for investors to take profit on the rally is currently high,” Unicredit analysts said in a research note.

Meanwhile, U.S. services industry activity picked up in November, offering more evidence of underlying momentum in the economy.

The ECB should raise interest rates by 50 bps on Dec. 15, French central bank chief Francois Villeroy de Galhau said on Sunday, reinforcing expectations for the ECB to slow the pace of monetary tightening after back-to-back 75 bp hikes.

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Governing council member Gabriel Makhlouf stressed the rates would have to move into “restrictive territory” next year.

Analysts also flagged that Villeroy de Galhau and Bundesbank President Joachim Nagel said in a joint interview with German TV that the ECB was determined to “bring inflation back to 2% by the end of 2024 or 2025.”

Investor morale in the euro zone rose this month to its highest level since June, according to data from Sentix’s index.

“For some more dovish ECB members that are anxious about sparking a recession, the (Sentix) data this morning may provide them with the reassurance to vote for 75bp as we are forecasting,” said George Moran, economist at Nomura.

France’s government bonds showed little impact from rating agency S&P Global cutting the sovereign’s outlook to “negative” from “stable,” with the 10-year yield rising 1 bp to 2.32%.

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Germany’s yield curve was not far off its deepest inversion since 1992. The gap between the 2-year and 10-year government bond yields was at -27.5 bps. Last Thursday, it hit -31.1 bps, the widest negative gap since October 1992.

Analysts said an inversion suggested that investors expect the ECB to pause its rate hikes or even cut them next year as inflation will start declining faster than expected or because the central bank wants to avoid deepening a recession.

Italy’s 10-year yield fell 2 bps to 3.75%, pushing the closely watched spread between German and Italian 10-year yields to 186 bps. (Reporting by Stefano Rebaudo, additional reporting by Samuel Indyk; editing by Susan Fenton, Bernadette Baum and Jonathan Oatis)