April 12 (Reuters) - Euro zone government bond yields dropped sharply on Friday as markets increased bets on future European Central Bank rate cuts and fears of a broadening of the Middle East conflict triggered some bids for safe-haven assets.
The ECB said on Thursday it might cut rates soon but failed to trigger a repricing of market bets on future rate cuts after strong U.S. economic data led investors to reduce expectations for future monetary easing there.
Gold surged to a fresh peak on Friday, supported by safe-haven demand amid ongoing tensions in the Middle East.
Analysts said investors are closing short positions on euro area government bonds opened after two weeks of strong U.S. data and hawkish remarks from Federal Reserve officials, with fears of a confrontation between Iran and Israel and the U.S. weighing on market sentiment.
"We do see geopolitical risks impacting markets a bit more than usual with investors watching closely developments on Israel and Iran," said Joost van Leenders, senior investment strategist at Van Lanschot Kempen.
Israeli Defence Minister Yoav Gallant said on Thursday that Israel would respond directly to any attack by Iran. The Pentagon said it discussed with Gallant the United States' "iron-clad" commitment to Israel's security against threats from Iran and its proxies.
Evelyne Gomez-Liechti, rates strategist at Mizuho Bank said markets were in a “consolidation phase.”
"The risk of an Iranian attack on Israel during the weekend will likely help the bid in rates," she argued.
Germany's two-year government bond yield, more sensitive to the outlook of policy rates, dropped 7 basis points (bps) to 2.90% and was set to end the week 3 bps higher. Benchmark 10-year Bund yield fell 9 bps to 2.39%.
Money markets last priced in around 80 bps of monetary easing in 2024 from 75 late on Thursday and from 87 bps on Wednesday before the U.S. data. They also discounted an around 90% chance of a 25-basis-point first move by June.
The ECB policy meeting was relatively uneventful for the market as the ECB confirmed it would be data-dependent, with economists looking for hints about the future policy path.
"We interpret some of the indirect messages on inflation and financial conditions as being on balance more consistent with gradual/quarterly cuts than continuous/back-to-back cuts," said Deutsche Bank chief economist Mark Wall.
"President Lagarde also argued the ECB is independent of the Fed, but at the same time was clear that U.S. data is taken into account," he added.
The Italian 10-year bond yield was 11.5 bps lower at 3.75%. The gap between Italian and German 10-year borrowing costs – a gauge of risk premium investors ask to hold bonds for the euro area's most indebted countries – tightened to 135 bps. (Reporting by Stefano Rebaudo Editing by Peter Graff)
