Euro zone bond yields edge down on French inflation data, tariff concerns

By Stefano Rebaudo

May 27 (Reuters) - Euro area bond yields dropped on Tuesday after French inflation data came in weaker than expected, while concerns about the potential adverse economic impact of U.S. tariffs persisted.

Borrowing costs edged up on Monday as the U.S. backed away from its threat to slap 50% tariffs on European imports, before falling later in the session in the wake of U.S. Treasury market worries about the effects of erratic U.S. trade policy.

French inflation fell to its lowest level since December 2020 in May, driven by a sharper decline in energy prices and a slowdown in service costs.

Germany’s 10-year government bond yield DE10YT=RR, the euro area benchmark, dropped 2.5 basis points (bps) to 2.54% after hitting 2.513%, its lowest level since May 8.

U.S. stock index futures jumped on Tuesday after tensions between the United States and the European Union cooled, favouring some selloff in safe-haven bonds.

On the euro zone front, markets await more inflation data from Germany, Italy and Spain on Friday.

The normalisation of interest rates in the euro zone is probably not complete, European Central Bank (ECB) policymaker Francois Villeroy de Galhau said on Tuesday.

However Austrian central bank governor Robert Holzmann, seen as a hawk, called for a pause in rate cuts until September.

Markets price in a 90% chance of an ECB 25 bps rate cut next week. They also indicated a depo rate at 1.67% EURESTECBM5X6=ICAP in December, which implies an additional easing move and an around 30% chance of a third cut by year-end. The depo rate is currently at 2.25%.

Data showed that the euro zone economic sentiment improved in May.

The benchmark 10-year U.S. Treasury yield US10YT=RR was down 5 bps to 4.46% in London trade. Analysts mentioned a possible regulatory relief which could favour more demand for bonds, driving yields lower, and concerns about rising public deficit.

Market participants expect U.S. regulators to revamp the "supplementary leverage ratio", reducing the amount of cash reserves banks must hold and encouraging them to play a larger role in intermediating Treasury markets.

A tax and spending bill which would saddle the U.S. with more debt now heads to the Senate, with several senators saying they would seek substantial changes over what is likely to be weeks of debate.

Italy’s 10-year yield IT10YT=RR rose 0.5 bps to 3.56%, with the gap between Italian and German yields DE10OT10=RR at 99.50 bps, after reaching 90.90 bps last week, its lowest level since March 2021.