Euro zone bond yields drop as German inflation slows

Euro zone bond yields drop as German inflation slows

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LONDON — Euro zone government bond yields fell for the second day running on Tuesday after German inflation cooled more than expected.

German inflation eased in December due to falling energy prices and the government’s one-off payment of household energy bills, coming in below expectations.

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“The decline in inflation in German states in December was bigger than expected,” said Franziska Palmas, senior Europe economist at Capital Economics.

Palmas said the figures “suggest that inflation figures for Germany as a whole and for the euro zone… will show a much larger fall in the headline rate than expected.”

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Germany’s 10-year government bond yield was down 6.5 basis points (bps) to 2.38%.

It fell 12 bps on Monday as investors anticipated a slowdown in euro zone inflation. Yields move inversely to prices.

Florian Ielpo, head of global macro at Lombard Odier, said the German numbers boosted expectations the European Central Bank (ECB) might raise interest rates by less than previously assumed, reducing pressure on bonds.

Italy’s 10-year bond yield was down 7 bps to 4.49%, after falling 15 bps on Monday. The spread between Germany’s and Italy’s 10-year bond yields narrowed slightly to 209 bps.

Germany’s 2-year bond yield, which is sensitive to expectations on policy rates, fell 1.5 bps to 2.67%, after rising earlier in the session.

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“Let’s not rush to conclusions,” Ielpo added. “We’ve had two inflation reports in Europe showing declining inflation, which is great but is pretty much reflective of what’s happening in energy markets.”

FALLEN SHARPLY

Energy prices have fallen sharply in recent months, in part because of mild weather.

“It’s the job of the ECB to be worried about wage or demand-driven inflation,” Ielpo said.

German headline inflation, adjusted to compare with the rest of the euro zone, is expected to slow to 10.7% year-on-year in December, from 11.3% in November, in part because of a government subsidy for energy bills.

However, comments from ECB policymakers have made clear that more rate hikes are coming. The ECB has raised rates from -0.5% in July to 2% in December, hammering European government bonds.

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The ECB is likely to raise rates significantly at its next two meetings in February and March, Latvian central bank governor Martins Kazaks said on Tuesday.

ECB chief Christine Lagarde on Saturday said euro zone wages were rising quicker than expected. Joachim Nagel, president of Germany’s central bank, on Monday said the ECB should continue tightening its monetary policy to curb inflation expectations.

Francesco Maria Di Bella, fixed income strategist at UniCredit, said it was hard to read too much into market moves.

“Strong fluctuations are … due to the fact liquidity is still low,” he said.

Euro zone-wide inflation data, due on Friday, is expected to show prices rose 9.7% in the year through December, down from 10.1% the previous month.

Euro zone bonds tanked in 2022, with the benchmark German 10-year notching its biggest annual fall since at least the 1950s, as the ECB and U.S. Federal Reserve hiked interest rates. Higher rates typically cause investors to demand higher returns on bonds, hurting prices. (Reporting by Harry Robertson Additional reporting by Stefano Rebaudo Editing by Ed Osmond and Mark Potter)

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