Euro zone yields edge down after weak data from France, Germany

By Stefano Rebaudo

Jan 31 (Reuters) - Euro zone yields fell on Tuesday after economic data revived fears of a marked economic slowdown, while investors got ready for a 50 basis point rate hike and possibly further hawkish guidance at the European Central Bank policy meeting.

France managed to eke out meagre growth in the final quarter of 2022, while German retail sales unexpectedly fell.

"Economic data from Germany and France showing a slowdown in the European economy are affecting bond prices," Joost van Leenders, senior investment strategist at Van Lanschot Kempen.

"Markets expect the ECB to hike rates by 50 bps twice by March, while there is more uncertainty about what will happen then," he added.

Germany’s 10-year government bond yield, the benchmark of the bloc, fell 3.5 basis points (bps) to 2.28%. It hit its lowest in a month at 1.97% on Jan. 18 and its highest since July 2011 at 2.57% on Dec. 30.

"In line with the ECB's recent 'higher for longer' mantra, ECB President Christine Lagarde will likely push back against market expectations that the bank will start cutting rates again late this year or in early 2024," said Holger Schmieding, an economist at Berenberg.

ECB euro short-term rate (ESTR) forwards implied the deposit rate would peak at 3.5% this summer. Traders were betting that rates would peak at around 3.3% before Spain's inflation numbers released on Monday.

The ESTR published by the ECB reflects the wholesale euro unsecured overnight borrowing costs of banks in the euro area. It's usually around 10 bps below the deposit rate.

Spain's inflation was at 5.8% versus 5.5% in December and above the 4.7% expected by analysts polled by Reuters.

Economists recently polled by Reuters expected the ECB to deliver a 50 bps rate hike at its policy meeting on Thursday and to stop when the deposit rate reaches 3.25% next quarter.

France's inflation was 7.0% in January, up from 6.7% in December, while euro area numbers are due on Wednesday.

Crucial euro zone inflation data will only include an estimate for Germany after the bloc's biggest country delayed the release of its own figures, Eurostat said on Monday.

"This makes the guesswork for tomorrow's HICP (harmonised index of consumer prices) not easier, where the flash number will have to be estimated without German input," Christopher Rieger, head of rates and credit research at Commerzbank said.

"If anything, the missing German numbers could mean downside risk to headline and upside risk to core inflation in the HICP Eurostat estimates," he added.

Italy's 10-year government bond yield fell 5 bps to 4.269%, with the gap between Italian and German 10-year yields -- a gauge of the risk premium for the government bonds of Southern Europe's highly indebted countries – tightening to 195 basis points. (Reporting by Stefano Rebaudo; editing by Jason Neely)