Euro zone government bond yields drop before US inflation data

By Stefano Rebaudo

July 15 (Reuters) - Euro zone government bond yields dropped on Tuesday, partly reversing recent gains, as investors await U.S. inflation data later in the session which could provide clues about the Federal Reserve's interest rate policy path.

The U.S. figures will show how tariffs affected inflation in June after data from previous months came in cooler than economists had forecast.

German 10-year yields DE10YT=RR, the euro area’s benchmark, fell 4.5 basis points (bps) to 2.69%, after hitting 2.737% on Monday, the highest since March 28.

"U.S. June consumer price inflation is the first number that might show trade tax effects," said Paul Donovan, chief economist at UBS Global Wealth Management, adding that half the expected tariff increases have hit the economy so far and pre-tariff inventory is still available after recent stockpiling.

Many importers recently boosted orders on expectations of higher U.S. tariffs and prices.

The 30-year yield DE10YT=RR was down 5 bps at 3.21%, after reaching 3.26% on Monday, its highest level since October 2023.

The two-year – more sensitive to expectations for European Central Bank policy rates – fell 2.5 bps to 1.85%.

The German yield curve flattened slightly, with the spread between 10-year and two-year yields DE2DE10=RR down 1.5 bps at 83.50 bps. It climbed 6.1 bps the day before, in its biggest daily rise since April 7 after a jump in Japanese yields.

The curve steepens when long-dated yields increase more quickly than the short-dated ones.

Markets have priced in an ECB terminal rate roughly unchanged at around 1.75–1.80% EURESTECBM4X5=ICAP, while yields on longer maturities have risen amid expectations of a significant increase in German fiscal spending.

French 10-year yields FR10YT=RR fell 5 bps to 3.38%, with the gap between French and German yields DE10FR10=RR, a market gauge of the risk premium investors demand to hold French debt, at 70 bps.

Investors are focusing on the approval of the budget, after French Prime Minister Francois Bayrou survived his latest no-confidence motion in parliament early this month.

"The most likely path seems a gradual dilution of saving measures with the final budget potentially targeting a deficit of around 5% of GDP and with further slippage during the year," said Aman Bansal, director of European rate strategy at Citi.

Citi targets an OAT-Bund spread of 75 bps in 2025, aligning with its BTP-Bund spread target, and says the OAT-BTP spread will likely turn positive next year.

Citi sees a yield gap between OATs and Bunds at 60 bps if the government succeeds in getting the budget approved.

Italy’s 10-year government bond yields IT10YT=RR were down 4.5 bps at 3.57%, with the spread between BTPs and Bund yields at 88 bps. It hit 84.20 bps earlier this month, its lowest level since March 2015.