Euro zone yields drop, traders increase bets on ECB rate cuts after data

Jan 31 (Reuters) – Euro zone government bond yields fell and traders increased their bets on future rate cuts from the European Central Bank after a raft of data pointed to a weak economic outlook.

Borrowing costs inched higher early on Friday, after falling the day before, as Thursday’s European Central Bank policy meeting confirmed investors’ expectations for further monetary easing.

Data from Germany suggested that the national inflation rate could decline this month, although it had been expected to remain unchanged, while French consumer prices increased slightly less than anticipated to 1.8% year-on-year.

Germany’s unemployment rate rose as the weakness of Europe’s biggest economy took its toll on the labour market.

“National and state level inflation data published so far suggest that euro-zone inflation may come in a bit lower than anticipated,” said Andrew Kenningham, chief Europe economist at Capital Economics.

“Services inflation in the largest (German) state, North Rhine Westphalia, fell” despite a significant increase in public transport inflation, he added.

Germany’s 10-year bond yield, the euro area’s benchmark, fell 4 basis points (bps) to 2.48%.

“We expect overall inflation in France to remain close to the current level on average over 2025 before returning to close to 2% in 2026,” said Charlotte de Montpellier, senior economist, France and Switzerland at ING.

However, euro zone consumers and economists increased their inflation expectations for this year, surveys showed on Friday.

Money markets priced in an ECB deposit facility rate at 1.95% at the end of 2025 — which implies three 25 bps cuts and a 20% chance of a fourth move by year-end — from around 2.05% before data. The depo rate is at 2.75%.

Germany’s two-year bond yield, more sensitive to ECB rate expectations, was down 8 bps at 2.115%, its lowest level since Jan. 3.

Markets now await later in the session the U.S. Personal Consumption Expenditures (PCE) Price Index, the Federal Reserve’s preferred measure of inflation.

The yield spread between OATs and Bunds — a market gauge of the risk premium investors demand to hold French debt — stood at 74.50 bps, after French Finance Minister Eric Lombard said on Friday that talks on getting the 2025 budget passed through parliament were “on the right track”.

It widened to around 90 bps, its highest since 2012, in mid-January and end-November amid fears that France would be unable to cut its growing budget deficit.

Italy’s 10-year yield was 3.5 bps lower at 3.57%. The gap between Italian and German yields was at 108 bps, not far from its lowest level since October 2021 at 104.50 bps. (Reporting by Stefano Rebaudo Editing by Gareth Jones)