Euro area yields drop, Italian spread set for biggest weekly rise since June 2024
Euro zone government bond yields were on track for a weekly decline as the Israel-Iran air war entered its eighth day, with investors downplaying inflation concerns while awaiting clarity on potential U.S. involvement in the conflict.
President Donald Trump will decide on Iran in the next two weeks, while Germany and its European partners are open to further discussions.
German 10-year government bond yields, which serve as the benchmark for the wider euro zone, fell 0.5 basis points (bps) to 2.51% and were set to end the week 2.5 bps lower.
Several analysts expect a relatively tight trading range for Bunds, barring any fresh shocks, while noting that the current rise in oil prices is insufficient to boost inflation.
"The bearish risks to (euro area) core rates are relatively tame, in our view. The German fiscal U-turn is likely to have a persistent impact on long-term forwards, but that is already well priced," said Jamie Searle, strategist at Citi, arguing he is neutral on Bunds at 2.5% with a preference to buy the dips.
Germany announced in early March a massive increase in fiscal spending to fund infrastructure and defence investments.
"On the bullish side, it feels like the market may have become complacent on tariff risk once again," Citi's Searle added, also mentioning possible support is the potential for reallocation to euro from the U.S. dollar with Bunds a likely beneficiary as the safest asset.
Money markets priced in a European Central Bank deposit facility rate at 1.77% in December from 1.75% last week. It priced a depo rate at around 1.6% in early April when concerns about the economic impact of U.S. tariffs led investors to discount a dovish response from the ECB.
"I believe there is a growing recognition that the European Union can play a larger role, especially if it develops a more comprehensive fiscal union rather than just a monetary union," said Kristina Hooper, chief market strategist at Man Group.
"There will be a willingness among investors to shift at least somewhat to euro-area bonds, primarily German bunds."
The yield on German 2-year bonds – more sensitive to expectations for the ECB policy rates -- was flat at 1.84%.
A decline in risk appetite widened the yield spreads between government bonds of highly indebted countries—such as Italy and France—and safe-haven German Bunds.
Italy's 10-year yields dropped 0.5 bps to 3.54%.
The Italian yield gap versus Bunds — a market gauge of the risk premium investors demand to hold Italian debt — was at 102.5 bps on Friday but was still set to end the week 10.8 bps wider, the largest increase since June 2024.
The French yield gap was set for the third straight weekly rise and was last 73.50 bps, after hitting early in the session 75.30 bps, its highest since April 23.
In France, the business climate index for June was at 96, below the long-term average and consensus expectations.
(Reporting by Stefano Rebaudo, Editing by Andrew Cawthorne)
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