Oct 24 (Reuters) - Euro zone government bond yields fell on Tuesday after PMI data in Germany and France provided some recessionary signals that might challenge expectations that interest rates will stay at high levels for an extended period.
The mood in France's services sector improved more than expected in October, although it remained negative overall, while German business activity suggested a recession was underway.
Germany’s 10-year yield, the benchmark for the euro area, was down 7 basis points (bps) at 2.80%. It hit 3.024%, its highest level since July 2011, in early October.
The euro zone’s borrowing costs have recently tracked moves in U.S. Treasuries, with the run-up in yields on the 10-year U.S. note driven by investors pricing in more robust U.S. growth and fiscal slippage.
Some analysts said most of the recent bond selloff came from the removal of recession risks and the correlated rise in the long-term expectations for interest rates in the U.S.
Such a move triggered a narrowing of curve inversion on both sides of the Atlantic. An inverted curve, usually a reliable indicator of a future recession, means markets are pricing events that would trigger central bank rate cuts.
The gap between Germany’s 2-year and 10-year yields was at -34 bps on Tuesday, after hitting its highest level in over six months at -20.9 in early October.
Investors' focus will soon shift to the European Central Bank policy meeting due on Thursday. Analysts expect the ECB to leave rates unchanged while reiterating that they will stay at high levels for an extended period.
Some analysts fear geopolitical tensions might fuel inflationary pressures, leading central banks to raise rates again, but they don’t expect the ECB to make such a move before early next year.
Oil prices rose on Tuesday as investors remained nervous that the Israel-Hamas war could escalate into a wider conflict in the oil-exporting region, causing supply disruptions.
Italy’s 10-year yield, the benchmark for the euro area periphery, fell 7 bps to 4.77%.
The spread between Italian and German 10-year government bond yields -- a gauge of the premium investors ask to hold debt of the euro area’s most indebted countries -- was at 195 bps, its lowest in a week.
Expectations that the ECB will be cautious on ending reinvestments from the Pandemic Emergency Purchase Program (PEPP) earlier than the current deadline at the end of 2024 are supporting peripheral bonds.
ECB president Christine Lagarde called PEPP reinvestments the first line of defence against so-called fragmentation -- an excessive yield spread widening between core and peripheral bonds, which might hamper the smooth transmission of the monetary policy across the euro area. (Reporting by Stefano Rebaudo; Editing by Bernadette Baum)
