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Euro zone bond yields edge lower after PMI, focus on ECB

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Euro zone government bond yields edged lower on Tuesday, as Purchasing Managers’ Index (PMI) data failed to provide direction while investors tried to assess the European Central Bank’s future monetary tightening path.

Analysts said Bunds had priced recent inflation relief but haven’t adjusted to the growth improvement, adding there is more room to price higher yields.

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Euro zone business activity made a surprise return to modest growth in January, adding to signs the downturn in the bloc may not be as deep as feared and that the currency union may escape recession, a survey showed.

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ECB policymakers laid out diverging views on future interest rate hikes on Monday, suggesting that moves beyond next week’s half a percentage point increase remain contentious.

Germany’s 10-year government bond yield, the bloc’s benchmark, fell 2 basis points (bps) to 2.18%. It hit its highest level since July 2011 on Jan. 2 at 2.569%.

Lower global energy prices and a slowdown in inflation have spurred bets that central banks may soon slow the pace of their interest rate increases, driving the 10-year Bund yield as low as 1.967% on Jan. 18.

According to economists polled by Reuters, the ECB will deliver 50 basis-point interest rate rises at each of its next two meetings. Forecasts still risk lagging behind policymakers’ guidance on how high rates will go.

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Financial markets expect the main policy rate to peak at 3.3% in August 2023, according to forwards on the ECB euro short-term rate (ESTR). That is a step down from December, when traders bet that rates would peak at 3.5%.

ING strategists led by Padraig Garvey said in a note they identified 2% for Bund yields and 2.5% for euro swaps as “the likely bottom of the range for EUR rates this year.”

“We think ECB policy will be instrumental in enforcing it, at least before the midway point of 2023,” they argued.

The euro 10-year interest rate swap was at 2.8%, after hitting an almost 7-week low at 2.48% on Jan 18.

Italy’s 10-year government bond yield fell 5 bps to 4.00%.

The spread between Italian and German 10-year yields – a gauge of the risk premium for the bonds of the more highly indebted countries of the euro zone – was at 178 bps. It hit its tightest since April 2022 at 163.8 on Jan. 19. (Reporting by Stefano Rebaudo; Editing by Jan Harvey)

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