European yields fall, focus starts shifting to data next week

LONDON: European bond yields dropped on Wednesday, driven by broader market optimism and supported by German business confidence data, as traders positioned themselves for a raft of key events next week. Germany's 10-year bond yield, the benchmark for the currency bloc, was at 2.12%, down 4 basis points (bps), extending the previous day's decline. Italy's 10-year yield was at 4.00%, down 5 bps.

"Markets are looking forward to next week when we have preliminary inflation figures from Germany and the eurozone as well as Federal Reserve and European Central Bank meetings," said Piet Haines Christiansen, director, of ECB and fixed income research at Danske Bank.

"We are in 'wait and see' mode, and recently, markets have tended to rally when they're in this situation because of 'fear of missing out' as market participants think a central bank pivot is coming."

A recent batch of stronger-than-expected data means a 50-basis point rate increase for the ECB next week is widely expected, but markets are pricing for rates in the United States to come down towards the end of this year, which could have an impact on expectations for rates elsewhere.

German business morale brightened in January, according to data on Wednesday, the latest sign that recession in Europe could be mild, or may not even materialize, echoing the tone of business activity surveys a day before. Yields also dropped at the short end of the curve, which is more sensitive to changes in expectations for monetary policy and inflation.

The German two-year yield fell 3 bps to 2.525% and Italy's two-year yield dropped nearly 5 bps to 3.0%. The German yield curve, as measured by the spread between the 10- and two-year yields were little changed and remained heavily inverted at -41.5 bps.