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German yields drop from highest in over decade before inflation data

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German government bond yields fell from their highest levels in more than a decade on the first trading day of 2023 as investors hoped inflation data would show a further decline.

The German consumer price index on Tuesday will kick off the release of national inflation data, which culminates in Friday’s euro area harmonized index of consumer prices (HICP).

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“In Spain, HICP inflation which dropped from 6.7% year-on-year in November to 5.8% year-on-year in December (consensus 5.8%, Citi 6.6%), points to potentially large downside surprises,” Citi analysts said.

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“We expect a further decline in headline inflation in December, driven by energy,” they added.

Spanish consumer prices rose in December at their slowest annual pace this year, thanks to lower electricity prices compared to a year ago, flash data showed on Friday.

Germany’s 10-year government bond yield fell 9.5 basis points (bps) to 2.47% after hitting its highest since 2011 at 2.57% on Friday.

The 2-year yield, most sensitive to policy rates, briefly hit a fresh 14-year high at 2.756% before falling by 5 bps to 2.68%.

A survey showed on Monday that France’s manufacturing sector contracted less than first thought in December, even though inflationary pressures continued to weigh.

ECB President Christine Lagarde said euro zone wages are growing quicker than earlier expected, and the central bank must prevent this from adding to already-high inflation.

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There is no sign of a “wage-price spiral” in the euro zone but the ECB should continue tightening its monetary policy to curb inflation expectations, ECB policymaker Joachim Nagel said.

Italy’s 10-year yield dropped 10.5 bps to 4.60% after hitting on Friday its highest since Oct. 24 at 4.70%.

The spread between Italian and German 10-year yields tightened slightly to 211 bps. It hit its widest since Nov. 3 at 222 on Dec. 20.

Bond supply is a crucial issue for investors, as governments will increase their spending to fight the adverse impact of the energy crisis.

“The annual net cash requirement should rise to a record high +€426bn, from +€101bn in 2022 under our base case for quantitative tightening (QT) and is expected to be most non-supportive for Bunds,” Citi analysts said.

From March, the ECB will start reducing its 5 trillion euros’ worth of bond holdings.

Market participants will also brace for the U.S. FOMC meeting’s minutes – due on Wednesday – and U.S. non-farm payrolls data, which will be released on Friday.

Some analysts, who expect U.S. job market strength to eventually cool down, argued that the upcoming prints are unlikely to be enough to provide the confidence needed to Fed Chair Jerome Powell to enhance rate cuts in 2023. (Reporting by Stefano Rebaudo, editing by Bernadette Baum)

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