LONDON/MILAN, Dec 11 (Reuters) - Euro zone yields held steady on Monday, stabilising after big price swings last week, as investors stayed on hold ahead of U.S. inflation data on Tuesday and policy decisions from many major central banks later in the week.
Borrowing costs on both sides of the Atlantic jumped on Friday after a robust read of the U.S. labour market led money markets to modestly scale back expectations for rate cuts in 2024.
Despite that, the benchmark 10-year Bund yield closed on Friday showing its biggest two-week fall since mid-March, as traders mostly stuck with their bets the European Central Bank will cut rates early next year.
Barring the mid-March fall – when bond yields tumbled on the collapse of Silicon Valley Bank (SVB) - the Bund yield headed at one point on Friday for its largest biweekly drop since the end of July 2011. By late afternoon on Monday, it was flat at 2.26%, having risen 7.5 bps on Friday.
Money markets are pricing in 135 basis points of rate cuts from the ECB in 2024, down from around 145 bps late on Thursday. They were pricing 80 bps worth of cuts at the end of November.
Analysts have brought forward their expectations for future cuts after weak inflation data and the aggressive shift in market pricing on rates, but they expect central banks to keep monetary policy unchanged this week.
Goldman Sachs forecast the Federal Reserve would cut rates for the first time in the third quarter of 2024, and expected the ECB to cut by 25 bps at each meeting starting April next year.
Citi analysts expect ECB policymakers to push back against the recent market repricing of the rate outlook "to be quite soft" at this week policy meeting, and "a quantitative tightening (QT) discussion/decision" to widen the spread between 10-year Italian bond yields and the euro short-term rate by 5-15 bps, while being "relatively neutral" on bonds.
ECB President Christine Lagarde said late last month the central bank might discuss an early end to reinvestments of its 1.7 trillion euro Pandemic Emergency Purchase Programme (PEPP), which would reduce excess liquidity.
"We remain sceptical that the ECB will deliver rate cuts as early as the market expects, as the outlook for underlying inflation remains uncertain," PIMCO portfolio manager Konstantin Veit said.
Veit added ECB policymakers might start discussing changes to PEPP reinvestments at the December meeting, but actual details might only filter through in the first quarter of 2024.
Much like the ECB, the Bank of England looks set to keep rates unchanged and to stick to its tough line against talk of interest rate cuts in Britain next week, even as other leading central banks signal that they might be approaching a turning point in their fight against inflation.
The Fed will meet on Wednesday, while the ECB and the BoE will meet on Thursday.
Italy's 10-year yields, the benchmark for the euro area periphery, were up 0.8 bps at 4.063%. The spread between Italian and German 10-year yields – a gauge of the risk premium investors ask to hold bonds of the most indebted countries – was at 178 bps after falling to 170 bps.
Markets will watch the Bank of Japan policy meeting next week. The yen surged late last week as investors weighed up the chances the BOJ could drop its negative interest-rate policy as early as January.
Analysts have warned a sharp rise in domestic yields could suck money back to Japan and out of global assets, including euro area and U.S. sovereign bonds. (Reporting by Stefano Rebaudo; Editing by Alex Richardson and Alison Williams) ;))