Euro zone government bond yields rise after PMI data

By Stefano Rebaudo

Jan 24 (Reuters) - Euro zone government bond yields rose on Friday after Purchasing Managers Index data showed a modest return to economic growth in the bloc, leading investors to slightly cut bets on the European Central Bank easing cycle.

France's services sector shrank further in January as businesses faced weak demand and political uncertainty, while Germany's private sector ended a six-month contraction.

However, the German government has slashed its growth projection for 2025 to 0.3%, down from 1.1% previously, the newspaper Handelsblatt cited government sources as saying.

Euro zone PMI nudged just above the 50 mark separating growth from contraction.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, was up 4 basis points (bps) at 2.55%, after being roughly unchanged before data. It was set to end the week 4.5 bps higher.

"Admittedly, the increase in the (euro area) Composite PMI was better than the consensus forecast of no change and left the index at a five-month high," said Jack Allen-Reynolds, deputy chief euro zone economist at Capital Economics.

However, "it's hard to argue that this was anything (other) than another weak survey as it is consistent with the economy stagnating," he added.

Money markets priced in a European Central Bank deposit facility rate slightly above 2.1% at the end of 2025, from 2.05% before data EURESTECBM8X9=ICAP.

Investors showed a muted reaction to remarks on tariffs by U.S. President Donald Trump earlier this week while shifting their focus to the ECB policy meeting next week.

They expect the ECB to cut rates by 25 bps, and will focus on any suggestions about the outlook of the easing cycle.

"By March, there may also be somewhat more clarity on a number of political fronts, including around U.S. tariffs on Europe and the outcome of the German election," Paul Hollingsworth, head of developed markets economics at BNP Paribas, said, after suggesting that the next week's policy meeting could be uneventful.

He flagged that the 25 bps rate cut looks like a done deal, and forward guidance is likely to be left unchanged.

Germany's two-year yield DE2YT=RR, more sensitive to ECB rate expectations, was up 4 bps at 2.28%, on track for a one bp weekly rise.

Italy's 10-year yield IT10YT=RR was 2 bps higher at 3.66%.

The gap between Italian and German yields DE10IT10=RR - a gauge of the risk premium investors demand to hold Italian debt - dropped to 110 bps. It hit 104.5 bps in early December, its tightest since October 2021.

The yield spread between French and German bonds DE10FR10=RR tightened one bp to 76.5 bps.