Bund yields rise after strong euro zone PMI, US inflation readings

By Stefano Rebaudo and Lucy Raitano

Oct 24 - Euro zone government bond yields rose on Friday after traders digested cool U.S. inflation figures as well as stronger-than-expected Euro zone purchasing managers' index readings, while French politics stayed in focus.

Yields eased slightly but later picked back up after a closely-watched U.S. government report showed consumer prices increased slightly less than expected in September, keeping the Federal Reserve on track to cut interest rates again next week.

Meanwhile, euro zone business activity unexpectedly grew at a faster pace in October, prompting investors to slightly scale back bets on a European Central Bank rate cut next year. French business activity declined faster than expected in October, while Germany's private sector recorded its strongest growth in nearly two and a half years.

Germany's 10-year Bund yields rose 5 basis points (bps) to 2.63%, on track for their biggest daily jump in six weeks.

Germany's two-year Bund yield, more sensitive to ECB rate-cut expectations, rose 4.3 bps to 1.98%.

"October's flash PMIs suggest that the euro zone economy may have picked up a bit at the start of the fourth quarter, although we suspect that growth will probably remain low at around 0.2% quarter on quarter," said Adrian Prettejohn, Europe economist at Capital Economics.

Borrowing costs on both sides of the Atlantic rose on Thursday after U.S. sanctions on Russia prompted a jump in oil prices, which stoked inflation concerns.

Benchmark U.S. Treasury 10-year yields US10YT=RR were up 4 bps at 4% after rising 3.5 bps a day earlier.

Money markets priced in a 50% chance of a 25-basis-point ECB rate cut by July EURESTECBM7X8=ICAP from 60% before the data. The key rate is seen at around 1.85% in December 2026 EURESTECBM10X11=ICAP from the current 2%.

"Overall, these PMIs clearly lean hawkish," said Giada Giani, an economist at Citi.

"The PMI cross-country divergence suggests fiscal policy may be behind the improving euro zone backdrop, already displaying some effects in Germany and continuing to support the periphery ... while holding back France," she added.

The yield gap between safe-haven Bunds and 10-year French government bonds DE10FR10=RR - a market gauge of the risk premium investors demand to hold French debt - widened to 80.89, while analysts expect France's credit rating to be downgraded to single-A in a Moody's review on Friday.

The French debt risk premium hit 87.96 bps earlier this month, the highest level since January 13, on concerns about the French fiscal outlook. It then fell to below 75 bps after Prime Minister Sebastien Lecornu survived two no-confidence votes in parliament.

However, the situation remains uncertain. On Friday, traders were digesting news that France's Socialists have threatened to topple the government by Monday if their budget conditions are not met.