(Bloomberg) -- A rally in euro-area government bonds this week gathered pace after another batch of weak economic data bolstered case for looser monetary policy in the region.
Data Friday showed inflation in France and Spain both slowed more quickly than expected, the latest sign economies across the bloc are losing momentum and in need of support. The yield on Germany’s two-year note fell sharply after the reports, touching the lowest level since December 2022, and taking a slide this week to 14 basis points.
Traders have moved to price in increasingly aggressive rate cuts from European Central Bank over the past few days, with the market now placing an 80% chance of a quarter-point move in October. Just last week, the idea the ECB would deliver another reduction swiftly off the back of a rate cut in September was seen as a fringe risk.
“Data is certainly supporting the view for an October cut,” said Pooja Kumra, head of European rates strategist at the Toronto-Dominion Bank.
Sentiment started to shift after data earlier this week showed the euro area’s private-sector economy shrank for the first time since March. Even ECB Executive Board member Isabel Schnabel — historically one of the more hawkish policymakers — appears to have become more concerned about the outlook, warning at an event on Thursday that the region is stagnating.
“We believe the weaker growth and inflation backdrop now argues for a faster pace,” said Peter Schaffrik, global macro strategist at RBC Capital Markets. “The arguments will have shifted sufficiently for the ECB to move already in October.”
France Woes
The rally was patchy though. French bonds were left behind amid concerns the fragile minority government will struggle to cobble together a budget that addresses the nation’s long-standing debt problem. As a result, the yield on 10-year bonds trade above those of lower-rated Spain for the first time since 2007, putting at risk France’s status as one of Europe’s safest debt markets.
French, Spanish Inflation Sinks Below 2%, Boosting ECB Cut Bets
The common currency also took a hit, dropping as much as 0.5% to $1.1125, before reversing part of that move.
“The writing maybe on the wall for the EUR,” said Valentin Marinov, Credit Agricole’s head of G10 FX research and strategy. While the market will wait for Eurozone HICP inflation next Tuesday for the full picture, “growing bets on an ECB cut next month could keep the pressure on the single currency in the near-term.”
--With assistance from Naomi Tajitsu.
(Updates with context on France.)
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