Euro zone bond yields tick up as markets scale back rate cut bets -November 24, 2023 at 11:02 am EST

Nov 24 (Reuters) – Euro zone government bond yields were
on track to close the week higher as investors balanced
recession fears against comments from European Central Bank
policymakers pushing against market expectations for rate cuts
in 2024.

Borrowing costs rose the day before after economic data
showed European economies were faring less badly than expected.
Separate data on Friday showed that U.S. business activity held
steady in November, boosting yields somewhat.

ECB policymaker Robert Holzmann, seen as a policy hawk,
reiterated that another rate hike was possible, after Belgian
policymaker Pierre Wunsch warned about “too optimistic” bets on
future cuts.

Germany’s 10-year government bond yield, the
benchmark for the euro area, rose 3 basis points (bps) to 2.65%,
a 1-1/2-week high. It was on track to end the week up 6 bps.

Money markets scaled back expectations for policy rate
reductions this week and are currently pricing in 83 bps by
December 2024 from 100 bps last Friday.

Policy rates derivatives also imply a 55% chance of a rate
cut in April, down from around 95% last
week.

“Overall, it (tight financial conditions) might lessen the
need for officials to push back more aggressively (against
expectations for rate cuts), although some would point out the
often-cited fragility of inflation expectations,” Benjamin
Schroeder ING senior rate strategist argued in a note.

German business morale improved less than expected in
November, a survey showed on Friday.

“The Ifo current conditions index remains consistent with a
severe recession despite today’s rise,” said Bradley Saunders,
economist at Capital Economics.

German Finance Minister Christian Lindner will propose a
supplementary budget for this year, which includes the
suspension of limits on new borrowing, but vowed the ruling
coalition will follow a strict course of austerity after a
budget crisis caused by a court ruling last week.

Analysts warned about a significant impact from a
substantial economic growth hit if the German government found
no solution to the budget crisis.

Italy’s 10-year government bond yield, the
benchmark for the euro area’s periphery, was flat at 4.397%.

The spread between Italian and German 10-year yields
– a gauge of the risk premium investors ask to
hold debt from the bloc’s most indebted countries – was at 173
bps. It hit 169.5 bps, its tightest level since Sept. 21, on
Tuesday after Moody’s improved the outlook of Italy’s credit
rating.

Policymakers should discuss at their meeting next month
whether to wind down bond reinvestments under the Pandemic
Emergency Purchase Programme (PEPP) early, the ECB’s Holzmann
said, suggesting to reduce reinvestments step by step as of
March.

The ECB can use reinvestments from the PEPP to support bonds
of southern Europe’s most indebted countries. ECB President
Christine Lagarde called it the first line of defence against
fragmentation – an excess widening of yield spreads among the
euro area’s bonds, which might hamper monetary policy
transmission.

The central bank confirmed at its last policy meeting in
October it would continue reinvestments from the PEPP until the
end of 2024. However, Lagarde said the council had yet to
discuss the issue.

Several analysts expect PEPP reinvestments to end at its
deadline in December next year.

The yield spread between Dutch and German 10-year yields
was at 33 bps after the party of anti-EU,
far-right veteran politician Geert Wilders won 37 out of 150
seats in Wednesday’s election, well ahead of 25 seats won by its
closest rival.

The yield spread hit 35.5 bps, a two-week high, on Thursday
after fluctuating between 40 and 25 bps since July.

Dutch party leaders met on Friday to begin the difficult and
lengthy process of trying to build a coalition.

(Reporting by Stefano Rebaudo, additional reporting by Harry
Robertson; editing by David Evans, Toby Chopra and Susan Fenton)