Euro zone yields drop, markets boost bets on ECB rate cuts after US data

By Stefano Rebaudo

Aug 1 (Reuters) - Euro area bond yields fell on Friday after data showed the U.S. economy created fewer jobs than expected, increasing the likelihood that the Federal Reserve will cut rates next month.

U.S. jobs growth slowed while the prior month's data was revised sharply lower, pointing to a sharp moderation in the labour market.

Analysts have recently argued that U.S. tariffs could trigger a growth shock significant enough to offset the expected one-off inflation effect, potentially prompting the Federal Reserve to kick off a new easing cycle.

They expect trade duties to put pressure on profit margins and households' real purchasing power.

Euro zone long-dated government bonds came under selling pressure before the U.S. figures, pushing yields higher as concerns over rising fiscal spending returned to the forefront.

Money markets increased their bets on future European Central Bank rate cuts, now pricing in around a 69% chance of an easing move by year-end EURESTECBM3X4=ICAP, up from 50% before the U.S. data release.

They also see a 90% chance of the same move by March 2026 EURESTECBM5X6=ICAP, compared to 65% previously.

"While it is important not to read too much into one data point, especially one as noisy as the (U.S.) non-farm payrolls, the news that job creation was below 20,000 in May and June will certainly give the Fed food for thought," said George Brown, senior economist at Schroders.

"Any further fragility could encourage an earlier easing cycle," he added.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone, fell 3.5 basis points (bps) to 2.66%.

Germany's two-year yield DE2YT=RR dropped 6 bps to 1.89%, after hitting 1.967%, its highest level since early April.

Data showed earlier in the session that euro zone inflation held steady at the ECB's 2% target in July.

“Overall, current inflation appears to be more persistent than anticipated,” said Ulrike Kastens, economist at DWS group.

“We continue to expect temporarily low inflation rates of just under 2.0% in the second half of 2025, but do not anticipate inflation undershooting the target in the longer term,” she added.

The yield gap between 10-year and 2-year German yields DE2DE10=RR widened 2.5 bps at 77 bps on Friday after tightening around 10 bps since mid-July, with analysts arguing that the long end of the euro curve has some room to catch up.

The yield curve steepens when long-dated yields rise quicker than the short-dated ones.