Euro Zone government bond yields drop on weak PMI data

EU bond yields: Euro zone government bond yields declined on Friday following weaker-than-expected economic survey data from France and Germany, bolstering expectations for policy rate cuts.

In France, weak demand dampened business activity as the country prepares for a snap parliamentary election. Meanwhile, Germany experienced a slowdown in economic growth in June.

Euro area business growth decelerated sharply this month as demand fell for the first time since February.

"Surveys suggest a solid recovery in the euro zone economy is not a done deal," said Franziska Palmas, senior European economist at Capital Economics. "Aggregate price pressures continued to ease but remained strong in the services sector, which will keep ECB policymakers cautious," she added.

Money markets now price in approximately 68 basis points of European Central Bank rate cuts by year-end, up from 65 basis points before the PMI data, indicating a further move and a 70 per cent chance of a third cut in 2024.

German 10-year bond yields, the euro area benchmark, fell 4.5 basis points to 2.38 per cent, though they were set to end the week 2 basis points higher. This follows diminished concerns over France's far-right National Rally (RN) party potentially implementing fiscally expensive pledges.

The spread between French and German 10-year yields, a measure of the risk premium for holding French government bonds, stood at 72 basis points, down from 82.34 basis points last Friday, the highest since February 2017.

"OATs (French government bonds) look priced for a hung parliament/RN-lead with a benign fiscal outcome but might widen sharply to 100 basis points over Bunds on a more forceful far-right/left manifesto implementation, while tightening to 60 basis points on a centrist coalition," Citi analysts said. France's 10-year yields fell 3.5 basis points to 3.12 per cent.

A recent survey indicated RN leading the first round of France's parliamentary elections with 35 per cent of the votes, while President Emmanuel Macron's centrist camp was in third place with 20 per cent.

Market sentiment towards France and the euro area's most indebted countries improved on Thursday after a French bond auction passed without incident. Additionally, hopes of monetary easing were sparked by the Swiss National Bank's unexpected rate cut and a dovish message from the Bank of England.

Italy's 10-year yield remained at 3.916 per cent, while the Italian-German yield gap stood at 152 basis points.

(With Reuters inputs)