Eurozone bond yields grapple with uncertainty ahead of ECB survey

Eurozone government bond yields steadied around the middle of their recent range as investors expect the European Central Bank (ECB) to be close to the end of its tightening cycle no matter what it decides at the next policy meeting.

Markets await the ECB’s Consumer Expectations Survey, which will be a significant input into next week’s ECB discussion.

The survey should provide further cues about whether the central bank needs to raise the deposit facility rate to 4 percent or stop at the current level of 3.75 percent.

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Money markets keep pricing an around 30 percent chance of a 25 basis points (bps) rate hike at the Sept. 14 ECB meeting. They also price a terminal rate at around 3.9 percent, which means a 60 percent chance of a rate hike by year-end.

ECB Chief Economist Philip Lane expressed cautious optimism that inflation was slowing but said a lot more data was needed before he would be comfortable declaring victory.

Germany’s 10-year government bond yield, the benchmark for the euro area, was flat at 2.58 percent. It fluctuated between 2.4 percent and 2.7 percent in August.

Later in the session, investors will closely watch the US Treasury’s reaction to US economic data after the long weekend. US markets were closed on Monday for Labor Day.

Analysts said that the Job Openings and Labor Turnover Survey (JOLTS) and Personal Consumption Expenditures (PCE) releases constitute enough evidence of progress towards disinflation and labor market rebalancing to keep the federal Reserve on hold in September.
Italy’s 10-year government bond yield, the benchmark for the euro area periphery, rose 1.5 bps to 4.31 percent.

The spread between Italian and German 10-year yields – a gauge of investor sentiment towards the eurozone’s more indebted countries – was at 170 bps after reaching on Monday its widest level in two weeks at around 172 bps.

The Italian spread has been remarkably resilient since the end of 2022 despite the ECB monetary tightening. It dropped to around 165 bps from above 250 bps in September 2022 as the government, led by Giorgia Meloni, stuck to European Union budget rules while the Italian economy performed better than expected.

“(Italy’s) BTP and (Portugal’s) PGB spreads still look too tight on our fundamental model based on consensus expectations for the country’s growth, budget balance and inflation,” Citi analysts said in a note to clients.

Italy is preparing to raise its 2023 budget deficit above the target of 4.5percent of gross domestic product (GDP).

Italy’s GDP shrank by 0.4 percent in the second quarter, according to data released last Friday that cast a shadow over the country’s economic prospects.

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